Filed Pursuant to Rule 424(b)(5)
Registration No. 333-25643
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED MAY 13, 2004)
[REDWOOD LOGO]
REDWOOD TRUST, INC.
1,050,000 SHARES
COMMON STOCK
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We are offering 1,050,000 shares of our common stock. Our common stock is
traded on the New York Stock Exchange under the symbol "RWT." On May 13, 2004,
the last reported sale price of our common stock on the New York Stock Exchange
was $45.20 per share.
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INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE S-5.
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PER SHARE TOTAL
-------------- --------------
Public offering price...................................... $45.200 $47,460,000
Underwriting discounts and commissions..................... $ 1.808 $ 1,898,400
Proceeds, before expenses, to us........................... $43.392 $45,561,600
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS IS TRUTHFUL OR COMPLETE.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
We have granted the underwriter the right to purchase up to an additional
150,000 shares of our common stock to cover over-allotments. The underwriter
expects to deliver the shares to purchasers on or about May 19, 2004.
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JMP SECURITIES
PROSPECTUS SUPPLEMENT DATED MAY 13, 2004
YOU SHOULD RELY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS SUPPLEMENT
AND THE ACCOMPANYING PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU
WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS SUPPLEMENT AND
THE ACCOMPANYING PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS SUPPLEMENT
AND THE ACCOMPANYING PROSPECTUS NOR SALE OF COMMON STOCK MEANS THAT INFORMATION
CONTAINED IN THIS PROSPECTUS SUPPLEMENT IS CORRECT AFTER THE DATE OF THIS
PROSPECTUS SUPPLEMENT. THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING
PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY THESE
SHARES OF COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH THE OFFER OR
SOLICITATION IS LAWFUL. IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING
PROSPECTUS, THE "COMPANY," "REDWOOD TRUST," "WE," "US," AND "OUR" REFER TO
REDWOOD TRUST, INC. AND ITS SUBSIDIARIES.
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TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT
PAGE
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Forward-Looking Statements and Notice about Information
Presented................................................. S-ii
Prospectus Supplement Summary............................... S-1
The Company............................................... S-1
Recent Developments....................................... S-2
The Offering.............................................. S-3
Summary of Selected Financial Data........................ S-4
Risk Factors................................................ S-5
Use of Proceeds............................................. S-15
Price Range of Common Stock and Dividends................... S-15
Common Stock Dividend Policy and Distributions.............. S-16
Capitalization.............................................. S-17
Selected Consolidated Financial Data........................ S-18
Company Business and Strategy............................... S-20
Federal Income Tax Considerations........................... S-27
Underwriting................................................ S-35
Experts..................................................... S-36
Legal Matters............................................... S-37
Incorporation By Reference.................................. S-37
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PROSPECTUS
PAGE
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About this Prospectus....................................... 2
Private Securities Litigation Reform Act of 1995............ 2
The Company................................................. 3
Use of Proceeds............................................. 3
Description of Securities................................... 3
Federal Income Tax Considerations........................... 8
Plan of Distribution........................................ 15
ERISA Investors............................................. 17
Legal Matters............................................... 17
Experts..................................................... 17
Where You Can Find More Information......................... 17
Incorporation by Reference.................................. 17
S-i
FORWARD-LOOKING STATEMENTS AND NOTICE ABOUT INFORMATION PRESENTED
This prospectus supplement and the accompanying prospectus contain or
incorporate by reference certain forward-looking statements. When used,
statements which are not historical in nature, including the words "anticipate,"
"estimate," "should," "expect," "believe," "intend," and similar expressions are
intended to identify forward-looking statements. These forward-looking
statements are subject to risks and uncertainties, including, among other
things, changes in interest rates on our mortgage assets and borrowings, changes
in prepayment rates on our mortgage assets, general economic conditions,
particularly as they affect the price of mortgage assets and the credit status
of borrowers, and the level of liquidity in the capital markets, as it affects
our ability to finance our mortgage asset portfolio.
Other risks, uncertainties and factors that could cause actual results to
differ materially from those projected are detailed from time to time in reports
filed by us with the Securities and Exchange Commission, or SEC, including Forms
10-Q and 10-K.
We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in or incorporated by reference into this
prospectus supplement and the accompanying prospectus might not occur.
This prospectus supplement contains statistics and other data that in some
cases have been obtained from, or compiled from, information made available by
servicing entities and information service providers.
S-ii
PROSPECTUS SUPPLEMENT SUMMARY
This summary highlights information contained elsewhere or incorporated by
reference in this prospectus supplement and the accompanying prospectus. This
summary does not contain all of the information that you should consider before
investing in our common stock. You should carefully read the entire prospectus
supplement and the accompanying prospectus, including in each case the documents
incorporated by reference, and with particular attention to the section entitled
"Risk Factors" beginning on page S-5 and our consolidated financial statements
and the notes to the consolidated financial statements incorporated by
reference.
THE COMPANY
We are a financial institution that invests in real estate loans. Our
primary market is high-quality jumbo residential real estate loans. Our primary
goal is to generate steady income and dividends for our stockholders.
We invest in, own and credit enhance high-quality residential real estate
loans originated throughout the United States. We also invest in real estate
loan securities created by pooling these loans. Our investments consist of
high-quality jumbo residential real estate loans, securities backed by jumbo
residential real estate loans, various other diverse residential and commercial
real estate loan securities, and commercial real estate loans. The interest
income we earn from these investments is derived from monthly loan payments made
by homeowners and property owners. This income covers our expenses, which are
primarily borrowing costs and operating expenses, and our dividend
distributions. Our status as a Real Estate Investment Trust, or REIT, allows us
to avoid paying certain income taxes by distributing the majority of our REIT
taxable income to our stockholders in the form of dividends.
We acquire high-quality jumbo residential real estate loans from various
large mortgage origination companies throughout the United States. Jumbo real
estate loans have mortgage balances that exceed the conforming loan limits
imposed upon Fannie Mae and Freddie Mac, two large U.S. government-sponsored
residential real estate loan investment companies. Most of our loans have
balances between $350,000 and $750,000 with an average balance over $430,000.
We also credit enhance loans by acquiring subordinated interests in pools
of high-quality residential real estate loans. We refer to these securities as
residential loan credit-enhancement securities as they effectively enhance the
credit of more senior securities within a securitized loan pool. Our returns on
credit-enhancement securities are driven primarily by the credit performance of
the underlying real estate loans.
We fund the majority of our real estate loan investments through
securitizations, where we issue mortgage-backed and asset-backed securities,
which are accounted for as long-term debt, using the real estate loan
investments as collateral. We believe this is an efficient form of long-term
financing that helps us maximize our return on equity while limiting our credit,
interest rate, and liquidity risk.
For each of our securitizations, specific real estate loan investments are
transferred to a securitization trust formed by a bankruptcy-remote special
purpose entity that is wholly owned by us. The securitization trust issues
multiple classes of securities with varying maturities and coupons. We sell most
of these securities, however we typically retain a portion of the subordinated
securities from each securitization for our own investment portfolio. There is
no gain or loss generated from the creation of these securitizations. We account
for these transactions as financings -- not sales -- and, therefore, we include
all of the assets associated with each securitization on our consolidated
balance sheet as assets and we include the securities issued by each
securitization as long-term debt.
Redwood Trust, Inc., our parent company, is organized as a REIT. Our REIT
status allows us to reduce certain income taxes by distributing at least 90% of
REIT taxable income (as defined in the REIT rules) to our stockholders in the
form of dividends. The REIT rules also allow us to temporarily defer (into the
next tax year) distributions of REIT taxable income. We may also permanently
retain up to 10% of our REIT taxable income as well as retain all income earned
by our taxable subsidiaries. We are subject to income taxes on retained taxable
income. We may defer dividend distributions and retain income from time to time
to help us maintain and grow our dividend-paying potential.
S-1
Redwood Trust, Inc. was incorporated in the State of Maryland on April 11,
1994, and commenced operations on August 19, 1994. Our executive offices are
located at One Belvedere Place, Suite 300, Mill Valley, California, 94941, (415)
389-7373.
On May 13, 2004, we had 19,894,687 outstanding shares of common stock,
traded on the New York Stock Exchange, under the symbol "RWT."
For more information about us, please visit our website at
www.redwoodtrust.com. We make available free of charge on our website our annual
report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on
Form 8-K (if applicable), amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act, and certain
"supplemental financial data" as soon as reasonably practicable after we
electronically file such material with, or furnish it to the SEC. None of the
information on our website and on websites linked to it is part of this
prospectus supplement or the accompanying prospectus, except to the extent
specifically incorporated herein.
RECENT DEVELOPMENTS
From March 31, 2004 through May 13, 2004, we purchased $1.2 billion of
adjustable-rate residential real estate loans, $86.1 million of residential and
commercial mortgage-backed securities and $10.5 million of residential
credit-enhancement securities. In addition, for settlement later in the second
quarter, we have committed to purchase $0.8 billion of adjustable-rate
residential real estate loans, $17.7 million "Acacia" securities, and $4.3
million of residential credit-enhancement securities. Included in these figures
are a small amount of commercial real estate loan credit-enhancement securities;
we intend to acquire more of these securities in the future. In addition, we
have also committed to purchase $310 million of home equity line of credit
(HELOC) loans made to high-quality borrowers, which is also a new product for
us. We intend to securitize these loans during the second or third quarter of
2004.
From March 31, 2004 through May 13, 2004, we issued $822 million of
long-term debt through Sequoia Mortgage Trust 2004-4, a trust established by our
wholly owned subsidiary Sequoia Residential Funding, Inc. This debt is
collateralized by pools of adjustable-rate residential real estate loans. We
also issued $293 million of long-term debt through Acacia CDO 4, LTD. This debt
is collateralized by residential and commercial real estate loan securities and
other asset-backed securities. The net proceeds received from these issuances
were used to acquire loans and pay down a portion of our short-term debt.
From March 31, 2004 through May 13, 2004, residential loan
credit-enhancement securities with a principal value of $7.2 million were called
pursuant to the original securitization documents. We recognized market value
gains on these calls of $2.8 million through net recognized gains and valuation
adjustments on our Consolidated Statements of Income.
In April 2004, we obtained a borrowing facility with a third party
financial institution totaling $450 million. This facility, which expires in
April 2005, will be used as short-term debt financing for the acquisition of
residential real estate loans.
In May 2004, we entered into a warehouse agreement with a Wall Street firm
to facilitate the accumulation of securities for a future collateralized debt
obligation or CDO.
In May 2004, our Board of Directors declared a regular cash dividend of
$0.67 per share, payable on July 21, 2004 to stockholders of record on June 30,
2004.
S-2
THE OFFERING(1)
Common stock offered.................. 1,050,000 shares
Common stock outstanding after this
offering(2)........................... 20,944,687 shares
Use of proceeds....................... We intend to use the net proceeds,
together with borrowings, to purchase
mortgage assets and for general
corporate purposes. See "Use of
Proceeds."
New York Stock Exchange trading
symbol................................ RWT
- ------------
(1) Does not include up to 150,000 shares of our common stock that may be issued
in connection with the underwriter's over-allotment option.
(2) Based on shares of common stock outstanding as of May 13, 2004.
S-3
SUMMARY OF SELECTED FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE DATA)
Our GAAP earnings (as calculated in accordance with Generally Accepted
Accounting Principles) totaled approximately $132 million or $7.09 per share for
2003, as compared to approximately $54 million or $3.44 per share for 2002, and
approximately $30 million or $2.88 per share for 2001. Our GAAP earnings totaled
approximately $51 million or $2.49 per share for the first quarter of 2004, as
compared to approximately $15 million or $0.88 per share for the first quarter
of 2003. Our 2003 and first quarter 2004 results were driven by the quality of
our existing real estate loan investments, a favorable operating environment,
excellent credit results, favorable prepayment patterns, increased capital
efficiencies, and income generated from discount securities that were called
during 2003 and 2004 at full face value.
AS OF OR FOR THE
AS OF OR FOR THE THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------------------- -------------------------
2003 2002 2001 2004 2003
----------- ----------- ----------- ----------- -----------
STATEMENT OF INCOME DATA:
Interest income....................... $ 330,976 $ 163,216 $ 144,539 $ 124,837 $ 61,125
Interest expense...................... (202,861) (91,705) (98,069) (79,577) (36,933)
----------- ----------- ----------- ----------- -----------
Net interest income................... 128,115 71,511 46,470 45,260 24,192
Operating expenses.................... (36,895) (20,005) (12,747) (10,026) (8,282)
Net recognized gains and valuation
adjustments......................... 46,676 5,111 1,532 17,437 918
Provision for income taxes............ (5,502) -- -- (1,880) (1,215)
Dividends on Class B preferred
stock............................... (681) (2,724) (2,724) -- (681)
----------- ----------- ----------- ----------- -----------
Net income before change in accounting
principle........................... 131,713 53,893 32,531 50,791 14,932
Cumulative effect of adopting EITF
99-20............................... -- -- (2,368) -- --
----------- ----------- ----------- ----------- -----------
Net income available to common
stockholders........................ $ 131,713 $ 53,893 $ 30,163 $ 50,791 $ 14,932
Average common shares -- basic........ 17,759,346 15,177,449 10,163,581 19,427,373 16,412,867
Net income per share -- basic......... $ 7.42 $ 3.55 $ 2.97 $ 2.61 $ 0.91
=========== =========== =========== =========== ===========
Average common shares -- diluted...... 18,586,649 15,658,623 10,474,764 20,398,644 16,983,513
Net income per share diluted.......... $ 7.09 $ 3.44 $ 2.88 $ 2.49 $ 0.88
=========== =========== =========== =========== ===========
Dividends declared per Class B
preferred share..................... $ 0.755 $ 3.020 $ 3.020 $ -- $ 0.755
Regular dividends declared per common
share............................... 2.600 2.510 2.220 0.670 0.650
Special dividends declared per common
share............................... 4.750 0.375 0.330 0.500 --
----------- ----------- ----------- ----------- -----------
Total dividends declared per common
share............................... $ 7.350 $ 2.885 $ 2.550 $ 1.17 $ 0.650
BALANCE SHEET DATA: END OF PERIOD
Earning assets........................ $17,543,487 $ 6,971,794 $ 2,409,271 $19,477,810 $ 8,134,604
Total assets.......................... 17,626,770 7,007,772 2,435,644 19,543,573 8,172,063
Short-term debt....................... 236,437 99,714 796,811 277,910 475,717
Long-term debt........................ 16,782,586 6,397,020 1,313,715 18,583,030 7,170,691
Total liabilities..................... 17,073,442 6,534,739 2,127,871 18,935,451 7,686,661
Total stockholders' equity............ $ 553,328 $ 473,033 $ 307,773 $ 608,122 $ 485,402
Number of Class B preferred shares
outstanding......................... -- 902,068 902,068 -- 902,068
Number of common shares outstanding... 19,062,983 16,277,285 12,661,749 19,796,237 16,604,910
Book value per common share........... $ 29.03 $ 27.43 $ 22.21 $ 30.72 $ 27.64
OTHER DATA:
Average assets........................ $11,058,272 $ 4,039,652 $ 2,223,280 $18,385,969 $ 7,553,726
Average borrowings.................... 10,489,614 3,616,506 1,945,820 17,747,434 7,036,183
Average reported total equity......... $ 526,808 $ 402,986 $ 254,021 $ 584,385 $ 489,086
GAAP earnings/average reported common
equity.............................. 25.3% 14.3% 13.3% 34.8% 12.9%
S-4
RISK FACTORS
You should carefully consider the following factors and other information
contained or incorporated by reference in this prospectus supplement and the
accompanying prospectus before deciding to purchase shares of our common stock.
The following is a summary of the risk factors that we currently believe
are important and that could cause our results to differ from expectations. This
is not an exhaustive list; other factors not listed below could be material to
our results.
We can provide no assurances with respect to projections or
forward-looking statements made by us or by others with respect to our future
results. Any one of the risk factors listed below, or other factors not so
listed, could cause actual results to differ materially from expectations. It is
not possible to accurately project future trends with respect to these risk
factors, to project which risk factors will be most important in determining our
results, or to project what our future results will be.
Throughout this prospectus supplement and other documents we release or
statements we make, the words "believe," "expect," "anticipate," "intend,"
"will," and similar words identify "forward-looking" statements.
WE ASSUME DIRECT CREDIT RISK IN OUR RESIDENTIAL REAL ESTATE LOAN INVESTMENTS.
REAL ESTATE LOAN DELINQUENCIES, DEFAULTS, AND CREDIT LOSSES COULD REDUCE OUR
EARNINGS AND CREDIT LOSSES COULD REDUCE OUR CASH FLOWS AND ACCESS TO LIQUIDITY.
As a core part of our business, we assume the credit risk of real estate
loans. We do this in each of our portfolios. We may add other product lines over
time that may have different types of credit risk than are described herein. We
are generally not limited in the types of credit risk or other types of risk
that we can undertake. As we acquire more credit-sensitive loans and securities,
we increase our credit risk exposure.
In our residential real estate loan portfolio, we assume the direct credit
risk of residential loans. Realized credit losses will reduce our earnings and
future cash flow. We have a credit reserve for these loans and we may continue
to add to this reserve in the future. There can be no assurance that our credit
reserve will be sufficient to cover future losses. We may need to reduce
earnings by increasing our credit reserve in the future.
Credit losses on residential real estate loans can occur for many reasons,
including: poor origination practices related to fraud; faulty appraisals;
documentation errors; poor underwriting; legal errors; poor servicing practices;
weak economic conditions; declines in the values of homes; special hazards;
earthquakes and other natural events; over-leveraging of the borrower; changes
in legal protections for lenders; reduction in personal incomes; job loss; and
personal events such as divorce or health problems.
If the U.S. economy or the housing market weakens or instances of borrower
fraud increase, our credit losses could be increased beyond levels that we have
anticipated. If we incur increased credit losses, our earnings might be reduced,
and our cash flows, asset market values and access to borrowings might be
adversely affected. The amount of capital and cash reserves that we hold to help
us manage credit and other risks may prove to be insufficient to protect us from
earnings volatility, dividend cuts, liquidity and solvency issues.
The manner in which we account for credit losses differs between Generally
Accepted Accounting Principles, or GAAP, and tax. While we may establish a
credit reserve for GAAP purposes, we are not permitted for tax purposes to
reduce our taxable REIT income to provide for a reserve for future credit
losses. Thus, if credit losses occur in the future, taxable REIT income may be
reduced relative to GAAP income. When taxable REIT income is reduced, our
minimum dividend distribution requirements under the REIT tax rules are reduced.
We could reduce our dividend rate in such a circumstance. Alternatively, credit
losses in some assets may be capital losses for tax. Unless we had offsetting
capital gains, our minimum dividend distribution requirement would not be
reduced by these credit losses, but eventually our cash flows would be. This
could reduce our free cash flow and liquidity.
Despite our efforts to manage our credit risk, there are many aspects of
credit that we cannot control, and there can be no assurance that our quality
control and loss mitigation operations will be successful in limiting future
delinquencies, defaults and losses. Our underwriting reviews may not be
effective. The representations and warranties that we receive from sellers may
not be enforceable. We may not receive funds that we believe are due to us from
mortgage insurance companies. Although we rely on our servicers, they may not
cooperate with
S-5
our loss mitigation efforts, or such efforts may otherwise be ineffective.
Various service providers to securitizations, such as trustees, bond insurance
providers and custodians, may not perform in a manner that promotes our
interests. The value of the homes collateralizing our loans may decline. The
frequency of default, and the loss severity on our loans upon default, may be
greater than we anticipated. Interest-only loans, negative amortization loans,
adjustable rate loans, loans with balances over $1 million, and loans that are
partially collateralized by non-real estate assets may have special risks. Our
geographical diversification may be ineffective in reducing losses. If loans
become "real estate owned," or REO, we or our agents will have to manage these
properties and may not be able to sell them. Changes in consumer behavior,
bankruptcy laws and the like may exacerbate our losses. In some states and
circumstances, we have recourse against the borrower's other assets and income,
however, in most cases, we may only be able to look to the value of the
underlying property for any recoveries. Expanded loss mitigation efforts in the
event that defaults increase could be costly. The interest rate on the bulk of
our loans is adjustable. Accordingly, when short-term interest rates rise,
required monthly payments from homeowners will rise under the adjustable rate
mortgages and this may increase borrowers' delinquencies and defaults. We expect
to continue to increase the size of our residential loan portfolio, and will
likely increase our GAAP balance sheet leverage with respect to these loans,
thus exposing us to a greater degree to the potential risks of owning these
loans.
WE HAVE CREDIT RISKS IN OUR RESIDENTIAL LOAN CREDIT-ENHANCEMENT SECURITIES
RELATED TO THE UNDERLYING LOANS. ACCOUNTING FOR SUCH INTERESTS REQUIRES US TO
MAKE MANY ASSUMPTIONS THAT MAY NOT BEAR OUT.
Our total net investment in residential credit-enhancement securities
includes a portion of securities that are in a first loss position with respect
to the underlying loans. Upon acquisition of a credit-enhancement security, we
generally expect that the entire amount of these first loss investments will be
subject to credit loss, potentially even in healthy economic environments. Our
ability to make an attractive return on these investments depends on how quickly
these expected losses occur. If the losses occur more quickly than we
anticipate, we may not recover our investment and/or our rates of return may
suffer significantly.
Second loss credit-enhancement securities, which are subject to credit
loss when the entire first loss investment (whether owned by us or by others)
has been eliminated by credit losses, make up another portion of our net
investment in credit-enhancement securities. Third loss credit-enhancement
securities, or other investments that are protected by various forms of material
credit-enhancement, make up the remainder of our net investment in
credit-enhancement interests. Given our normal expectations for credit losses,
we would anticipate some future losses on many of our second loss interests, but
generally do not anticipate losses on investments in the third loss or similar
positions. If credit losses are greater than, or occur sooner than expected, our
expected future cash flows will be reduced and our earnings will be negatively
affected. Credit losses and delinquencies could also affect the cash flow
dynamics of these securitizations and thus extend the period over which we will
receive a return of principal from these investments. In most cases, adverse
changes in anticipated cash flows would reduce our economic and accounting
returns and may also precipitate mark-to-market charges to earnings. From time
to time, we may pledge these interests as collateral for borrowings; a
deterioration of credit results in this portfolio may adversely affect the terms
or availability of these borrowings and, thus, our liquidity.
We generally expect to increase our net acquisitions of residential
credit-enhancement securities and to increase our net acquisitions of first loss
and second loss investments relative to third loss investments. This may result
in increased risk to us with respect to the credit results of the residential
loans we credit enhance.
In our credit-enhancement securities portfolio, we may in the future
benefit from credit rating upgrades or restructuring opportunities through
re-securitizations or other means. If credit results deteriorate, these
opportunities may not be available to us or may be delayed. It is likely, in
many instances, that we will not be able to anticipate increased credit losses
in a pool soon enough to allow us to sell such credit-enhancement interests at a
reasonable price.
In anticipation of future credit losses, we designate a portion of the
purchase discount associated with many of our credit-enhancement securities as a
form of credit protection. The remaining discount is amortized into income over
time through the effective yield method. If the credit protection we set aside
at acquisition proves to be insufficient, we may need to reduce our effective
yield income recognition in the future or we may adjust our basis in these
interests, thus reducing earnings.
S-6
DECREASES IN ESTIMATED CASH FLOWS ON CERTAIN SECURITIES AND LOANS MAY REDUCE
EARNINGS AS A RESULT OF DECLINES IN MARKET VALUES.
We adopted EITF 99-20 in the first quarter of 2001. Generally, under EITF
99-20, if prospective cash flows from certain investments deteriorate even
slightly from prior expectations (due to changes in anticipated credit losses,
prepayment rates, and otherwise) then the asset will be marked-to-market if the
market value is lower than our basis. Any mark-to-market adjustments under EITF
99-20 reduce GAAP earnings in that period. Since we do not expect every asset we
own to always perform equal to or better than our expectations, we expect to
take negative EITF 99-20 adjustments to earnings from time to time.
OUR BUSINESS MAY BE SIGNIFICANTLY HARMED BY A SLOWDOWN IN THE ECONOMY OF
CALIFORNIA.
As of March 31, 2004, approximately half of the residential real estate
loans that we own or credit enhance are secured by property in California. An
overall decline in the economy or the residential real estate market, or the
occurrence of a natural disaster that is not covered by standard homeowners'
insurance policies, such as an earthquake, could decrease the value of mortgaged
properties in California. This, in turn, would increase the risk of delinquency,
default or foreclosure on real estate loans in our residential loan portfolios.
This could adversely affect our credit loss experience and other aspects of our
business, including our ability to securitize real estate loans. As of March 31,
2004, approximately 65% of our commercial real estate loans and approximately
one-third of the loans underlying our securities portfolio are also secured by
properties located in California.
WE MAY HAVE CREDIT LOSSES IN OUR SECURITIES PORTFOLIO.
Most of our securities are backed by residential and, to a lesser extent,
commercial real estate loans. Most of these securities benefit from various
forms of corporate guarantees and/or from credit-enhancement provided by third
parties, usually through their ownership of subordinated credit-enhancement
interests. Thus, the bulk of our securities investments have at least some
degree of protection from initial credit losses that occur in the underlying
loan pools. However, in the event of greater than expected future delinquencies,
defaults or credit losses, or a substantial deterioration in the financial
strength of any corporate guarantors, our results would likely be adversely
affected. We may experience credit losses in our securities portfolio.
Deterioration of the credit results or guarantees of these assets may reduce the
market value of these assets, thus limiting our borrowing capabilities and
access to liquidity. Generally, we do not control or influence the underwriting,
servicing, management or loss mitigation efforts with respect to these assets.
Results could be affected through credit rating downgrades, market value losses,
reduced liquidity, adverse financing terms, reduced cash flows, experienced
credit losses, or in other ways.
For the non-investment grade assets in our securities portfolio, our
protection against credit loss is smaller and our credit risks and liquidity
risks are increased. If we acquire equity securities, results may be volatile.
We intend to continue to increase the percentage of our securities portfolio
that is rated below AA and that is rated below investment grade, and we intend
to continue to expand the range of types of securities that we acquire; these
trends may increase the potential credit risks in our securities portfolio. A
substantial portion of these lower rated securities are acquired in connection
with our Acacia program. Many of the loans underlying the securities we have
acquired for our securities portfolio are of lesser quality than the loans in
our high-quality residential loan portfolios; these lower quality loans can be
expected to have higher rates of delinquency and loss, and losses to our
security interests could occur. Changes in laws regarding origination practices
for lower-quality loans could reduce the value and credit-worthiness of some of
our securities and could expose us to litigation. Some of our securities are
backed by subprime residential, manufactured housing, second-lien, and diverse
commercial real estate loans that have additional risks not typically found with
residential real estate loans. Some of our securities are unsecured corporate
obligations of REITs that invest in commercial real estate properties; these
securities have commercial real estate risk but also may have additional risks
associated with unsecured lending to corporations. We may invest in other types
of securities that have risks that are not contemplated in this discussion.
WE ASSUME DIRECT CREDIT RISK IN OUR COMMERCIAL REAL ESTATE LOAN INVESTMENTS.
The loans in our commercial real estate loan portfolio, as well as the
loans that collateralize the commercial real estate loan securities we acquire,
may have higher degrees of credit and other risks than do our residential real
estate loans, including various environmental and legal risks. The net operating
income and market values of commercial real estate properties may vary with
economic cycles and as a result of other
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factors, so that debt service coverage is unstable. The value of the property
may not protect the value of the loan if there is a default. Our commercial real
estate loans are not geographically diverse, so we are at risk for regional
factors. Many of our commercial loans are not fully amortizing, so the timely
recovery of our principal is dependent on the borrower's ability to refinance at
maturity. In those cases in which we lend against commercial real estate, the
real estate is often in transition. Such lending entails higher risks than
traditional commercial property lending against stabilized properties. Initial
debt service coverage ratios, loan-to-value ratios, and other indicators of
credit quality may not meet standard market criteria for stabilized commercial
real estate loans. The underlying properties may not transition or stabilize as
we expect. The personal guarantees and forms of cross-collateralization that we
receive on some loans may not be effective. We generally do not service our
loans; we rely on our servicers to a great extent to manage our commercial
assets and work-out loans and properties if there are delinquencies or defaults.
This may not work to our advantage. As part of the work-out process of a
troubled commercial real estate loan, we may assume ownership of the property,
and the ultimate value of this asset would depend on our management of, and
eventual sale of, the property which secured the loan. Our loans are illiquid;
if we choose to sell them, we may not be able to do so in a timely manner or for
a satisfactory price. Financing these loans may be difficult, and may become
more difficult if credit quality deteriorates. We have sold senior loan
participations on some of our loans, so that the asset we retain is junior and
has concentrated credit, servicing and other risks. We have directly originated
some of our commercial loans, and participated in the origination of others.
This may expose us to certain credit, legal and other risks that may be greater
than is usually present with acquired loans. We have sold commercial real estate
loans. The representations and warranties we made on these sales are limited,
but could cause losses and claims in some circumstances. On a net basis, we
intend to increase our investment in commercial real estate loans and in junior
participations of these loans, mezzanine and second-lien loans that are junior
to senior loans and in investment grade and non-investment grade commercial real
estate loan securities.
OUR INVESTMENTS IN SUBORDINATED COMMERCIAL REAL ESTATE LOAN-BACKED SECURITIES
AND LOANS ARE SUBJECT TO LOSSES.
In general, losses on an asset securing a commercial real estate loan
included in a securitization will be borne first by the equity holder of the
property, then by a cash reserve fund or letter of credit, if any, and then by
the "first loss" subordinated security holder. In the event of default and the
exhaustion of any equity support, reserve fund, letter of credit, and any
classes of securities junior to those in which we invest, we will not be able to
recover all of our investment in the securities we purchase. In addition, if the
underlying loan portfolio has been overvalued by the originator, or if the
values subsequently decline and, as a result, less collateral is available to
satisfy interest and principal payments due on the related asset-backed
securities, the securities in which we invest may effectively become the "first
loss" position behind the more senior securities, which may result in
significant losses to us.
The prices of lower credit quality securities are generally less sensitive
to interest rate changes than more highly rated investments, but more sensitive
to adverse economic downturns or individual issuer developments. A projection of
an economic downturn, for example, could cause a decline in the price of lower
credit quality securities because the ability of obligors of loans underlying
commercial asset-backed securities to make principal and interest payments may
be impaired. In such event, existing credit support in the securitization
structure may be insufficient to protect us against loss of our principal on
these securities.
WE INTEND TO INVEST IN DIVERSE TYPES OF ASSETS WITH CREDIT RISKS THAT COULD ALSO
CAUSE LOSSES.
We intend to continue to invest in a variety of types of commercial real
estate loan assets, such as mezzanine loans, second liens, credit-enhancement
interests of commercial loan securitizations, junior participations, among
others, that may entail other types of risks. In addition, we intend to continue
to invest in other assets with material credit risk, including sub-prime
residential real estate loans and securities, the equity and debt of
collateralized debt obligations, or CDOs, corporate debt and equity of other
REITs and non-real estate companies, trust preferreds from banks, real estate
and non-real estate asset-backed securities, and other financial and real
property assets.
OUR RESULTS COULD ALSO BE ADVERSELY AFFECTED BY COUNTER-PARTY CREDIT RISK.
We have other credit risks that are generally related to the
counter-parties with which we do business. In the event a counter-party to our
short-term borrowings becomes insolvent, we may fail to recover the full value
of our collateral, thus reducing our earnings and liquidity. In the event a
counter-party to our interest rate agreements becomes insolvent or interprets
our agreements with them in an unfavorable manner to us, our
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ability to realize benefits from hedging may be diminished, and any cash or
collateral that we pledged to these counter-parties may be unrecoverable. We may
be forced to unwind these agreements at a loss. In the event that one of our
servicers becomes insolvent or fails to perform, loan delinquencies and credit
losses may increase. We may not receive funds to which we are entitled. In
various other aspects of our business, we depend on the performance of third
parties that we do not control. We attempt to diversify our counter-party
exposure and to limit our counter-party exposure to strong companies with
investment-grade credit ratings, however, we are not always able to do so. Our
counter-party risk management strategy may prove ineffective.
WE MAY BE SUBJECT TO THE RISKS ASSOCIATED WITH INADEQUATE OR UNTIMELY SERVICES
FROM THIRD-PARTY SERVICE-PROVIDERS, WHICH MAY AFFECT OUR RESULTS OF OPERATIONS.
The majority of our loans and securities are serviced by third-party
service providers. These arrangements allow us to increase the volume of the
loans we purchase without incurring the expenses associated with servicing
operations. However, as with any external service provider, we will be subject
to the risks associated with inadequate or untimely services. Many borrowers
require notices and reminders to keep their loans current and to prevent
delinquencies and foreclosures. A substantial increase in our delinquency rate
that results from improper servicing or mortgage loan performance in general
could adversely affect our ability to securitize our real estate loans in the
future.
WE ARE EXPOSED TO CERTAIN RISKS ASSOCIATED WITH THE ACCUMULATION OF REAL ESTATE
LOAN ASSETS PRIOR TO SECURITIZATION.
Our long-term goal is to fund most of our real estate loan and security
investments with the issuance of mortgage-backed and asset-backed securities
that are nonrecourse to us and are accounted for as the issuance of long-term
debt. Prior to securitization, we acquire and accumulate loans and securities
with short-term recourse debt or equity. During this accumulation period, we are
subject to certain risks such as liquidity risk, market value risk and credit
risk. Untimely execution of a securitization may accentuate these risks. In
addition, we may not be able to securitize certain assets, and, in such event,
our earnings and ability to grow may be adversely affected.
FLUCTUATIONS IN OUR RESULTS MAY BE EXACERBATED BY THE STRUCTURAL LEVERAGE THAT
WE EMPLOY AND BY LIQUIDITY RISK.
We report substantial GAAP balance sheet leverage relative to many
financial and non-financial companies, although we believe we employ less
leverage on a recourse basis than most banks, thrifts and other financial
institutions. The bulk of our financing is typically in the form of asset
securitization reported on our GAAP books as long-term debt. We believe this is
generally an effective and lower-risk form of financing compared to many other
forms of debt utilized by financial companies. We believe the amount of leverage
that we employ is appropriate, given the risks in our balance sheet, the
non-recourse nature of the mortgage-backed and asset-backed securities we issue,
the fact that our maximum credit losses are generally limited, and our
management policies. However, in order to operate our business successfully, we
require continued access to short-term debt and securitization assets on
favorable terms with respect to financing costs, capital efficiency, covenants
and other factors. We may not be able to obtain debt or issue securities on such
terms, and, in such event, our earnings and liquidity could be adversely
affected.
Relatively small changes in asset quality, asset yield, cost of borrowed
funds and other factors could have relatively large effects on us and our
stockholders, including fluctuations in earnings and liquidity. Our use of
securitizations and the resulting structural leverage may not enhance our
returns and could erode our financial soundness. In general, we currently intend
to increase our reported GAAP leverage in the future through asset accumulation
funded by non-recourse securitizations accounted for as the issuance of
long-term debt.
Although we do not have a corporate debt rating, the nationally-recognized
credit rating agencies have a strong influence on the amount of capital that we
hold relative to the amount of credit risk we take. The rating agencies
determine the amount of net investment we must make to credit enhance the
securities, mostly rated AAA, that we issue to fund our residential loan
portfolio. They also determine the amount of principal value required for the
credit-enhancement interests we acquire. The rating agencies, however, do not
have influence over how we fund our net credit investments nor do they determine
or influence many of our other capital and leverage policies. With respect to
our short-term debt, our lenders, typically large commercial banks and Wall
Street investment firms, limit the amount of funds that they will advance
against our collateral. We set aside more capital than required by our lenders.
However, recourse lenders can increase the amount of capital that they will
require of us, or the value of our collateral may decline, thus reducing our
liquidity.
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We are not regulated by the national regulatory bodies that regulate
banks, thrifts, and the U.S. government-sponsored real estate loan investment
companies Fannie Mae and Freddie Mac. Thus, the amount of financial leverage
that we employ is largely controlled by management, and by our internal risk-
adjusted capital policies.
In the period in which we are accumulating loans, securities, or other
assets in order to build a portfolio of efficient size to issue mortgage-backed
or asset-backed securities, variations in the market for these assets or for
securitization could affect our results. Ultimately, we may not be able to issue
securities, the cost of securitization could be greater than we anticipated, the
net investment in our securitization trust required by the rating agencies could
be greater than anticipated, certain of our assets could not be accepted into
the securitization trust, the market value of our assets to be sold into the
securitization trust may have changed, our hedging activities or agreements with
counter-parties may have been ineffective, or other negative effects could
occur.
We may borrow on a short-term basis to fund a portion of our securities
portfolio, certain credit-enhancement securities, residential loans, or other
assets prior to the issuance of securities, to use a certain amount of leverage
with respect to our net investments in credit-enhancement interests, to fund a
portion of our commercial loan portfolio, to fund working capital and general
corporate needs, and for other reasons. We borrow short-term by pledging our
assets as collateral. We can usually borrow through uncommitted borrowing
facilities for the substantial majority of our short-term debt because the
assets pledged as collateral are generally liquid, have active trading markets,
and have readily discernable market prices. The term of these borrowings can
range from one day to one year. To fund less liquid or more specialized assets,
we typically enter into credit line agreements from commercial banks and finance
companies with a one-year term. Whether committed or not, we need to roll over
short-term debt on a frequent basis; our ability to borrow is dependent on our
ability to deliver sufficient market value of collateral to meet lender
requirements. Our payment of commitment fees and other expenses to secure
borrowing lines may not protect us from liquidity issues or losses. Variations
in lenders' ability to access funds, lender confidence in us, lender collateral
requirements, available borrowing rates, the acceptability and market values of
our collateral, and other factors could force us to utilize our liquidity
reserves or to sell assets, and, thus, affect our liquidity, financial
soundness, and earnings. In recent years, we believe that the marketplace for
our type of secured short-term borrowing has been stable, but there is no
assurance that such stability will continue. Our current intention is to
maintain relatively low levels of short-term debt over time, with the exception
of short-term debt used to fund assets under accumulation for a securitization.
Our plans may change, however. In the future, we may also borrow on an unsecured
basis through bank loans, issuance of unsecured corporate debt, and other means.
Our various borrowing arrangements subject us to debt covenants. While
these covenants have not meaningfully restricted our operations to date, they
could be restrictive or harmful to us and our stockholders' interests in the
future. Should we violate debt covenants, we may incur expenses, losses, or
reduced ability to access debt.
DISRUPTIONS IN MORTGAGE SECURITIZATION MARKET MAY ADVERSELY AFFECT OUR EARNINGS
AND GROWTH.
We depend upon the issuance of securities to finance our operations. If
the market for securitizations should become disrupted, as occurred in 1998 due
to a liquidity crisis in debt markets for some capital market participants, we
may be unable to issue our securities, in which event our ability to continue to
acquire mortgage assets would be adversely impacted. In addition, if the
securitization market were to experience a long-term disruption, for example,
due to an adverse court decision or bankruptcy law change relating to the
bankruptcy-remote structures of the securitizations, our ability to issue
securitizations may be impaired or eliminated for a protracted period or
permanently. In such event, our earnings and ability to grow may be adversely
affected.
CHANGES IN THE MARKET VALUES OF OUR ASSETS AND LIABILITIES CAN ADVERSELY AFFECT
OUR EARNINGS, STOCKHOLDERS' EQUITY, AND LIQUIDITY.
The market values of our assets, liabilities and hedges are affected by
interest rates, the shape of yield curves, volatility, credit quality trends,
loan prepayment rates, supply and demand, capital markets trends and liquidity,
general economic trends, expectations about the future, and other factors. For
the assets that we mark-to-market through our income statement or balance sheet,
such market value fluctuations will affect our earnings and book value. To the
extent that our basis in our assets is thus changed, future reported income may
be affected as well. If we sell an asset that has not been marked-to-market
through our income statement at a
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reduced market price relative to our basis, our earnings will be reduced. Market
value reductions of the assets that we pledge for short-term borrowings may
reduce our access to liquidity.
Generally, reduced asset market values for the assets that we own may have
negative effects, but might improve our opportunities to acquire new assets at
attractive pricing levels. Conversely, increases in the market values of our
existing assets may have positive effects, but may mean that acquiring new
assets at attractive prices becomes more difficult.
CHANGES IN LOAN PREPAYMENT RATES MAY AFFECT OUR EARNINGS, LIQUIDITY, AND THE
MARKET VALUES OF OUR ASSETS.
Residential and commercial real estate loan prepayment rates are affected
by interest rates, borrower behavior and confidence, seasoning of loans, the
value of and amount of equity in the underlying properties, prepayment terms of
the loans, the ease and cost of refinancing, the property turnover rate, media
awareness of refinancing opportunities, and many other factors.
Changes in prepayment rates (including prepayments from liquidated
defaulted loans) may have multiple effects on our operations. Faster loan
prepayment rates may lead to increased premium amortization expenses for premium
and interest-only assets, increased working capital requirements, reduced market
values for certain types of assets, adverse reductions in the average life of
certain assets, adverse changes in hedge ratios, and an increase in the need to
reinvest cash to maintain operations. Premium assets may experience faster rates
of prepayments than discount assets. Slower prepayment rates may lead to reduced
discount amortization income for discount assets, reduced market values for
discount and other types of assets, extension of the average life of certain
investments at a time when this would be contrary to our interests, adverse
changes in hedge ratios, a reduction in cash flow available to support
operations and make new investments, and a reduction in new investment
opportunities, since the volume of new origination and securitizations would
likely decline. Slower prepayment rates may lead to increased credit losses.
The amount of net discount we have on our books is the net of a much
larger premium balance and a much larger discount balance. Changes in prepayment
rates that are not uniform across products could have a material effect on our
earnings. Therefore, our net amortization expense or income can change over time
as our asset composition changes through principal repayments, asset purchases,
and as we mark our assets to market.
INTEREST RATE FLUCTUATIONS CAN HAVE VARIOUS EFFECTS ON US, AND COULD LEAD TO
REDUCED EARNINGS AND/OR INCREASED EARNINGS VOLATILITY.
Our balance sheet and asset/liability operations are complex and diverse
with respect to interest rate movements, so we cannot fully describe all the
possible effects of changing interest rates. We do not seek to eliminate all
interest rate risk. Changes in interest rates, the interrelationships between
various interest rates, and interest rate volatility could have negative effects
on our earnings, the market value of our assets and liabilities, loan prepayment
rates, and our access to liquidity. Changes in interest rates can also affect
our credit results.
Generally, rising interest rates could lead to reduced asset market values
and slower prepayment rates. Initially, our net interest income may be reduced
if short-term interest rates increase, as our cost of funds would likely respond
to this increase more quickly than would our asset yields. Within three to
twelve months of a rate change, however, asset yields for our adjustable rate
residential loans may increase commensurately with the rate increase. Higher
short-term interest rates may reduce earnings in the short-term, but could lead
to higher long-term earnings, as we earn more on the equity-funded portion of
our balance sheet. If we own fixed rate assets that are funded with floating
rate debt, our net interest income from this portion of our balance sheet would
be unlikely to recover until interest rates dropped again or the assets matured.
Some of our adjustable rate residential loans have periodic caps that limit the
extent to which the coupon we earn can rise or fall, usually 2% annual caps, and
life caps that set a maximum coupon. If short-term interest rates rise rapidly
or rise so that our loan coupons reach their periodic or life caps, the ability
of our asset yields to rise along with market rates would be limited, but there
may be no such limits on the increase in our liability costs.
Falling interest rates can also lead to reduced asset market values in
some circumstances, particularly for prepayment-sensitive, premium, and other
assets and for many types of interest rate agreement hedges. Decreases in
short-term interest rates can be positive for earnings in the near-term, as our
cost of funds may decline more quickly than our asset yields would. For longer
time horizons, falling short-term interest rates can reduce our earnings, as we
may earn lower yields from the assets that are equity-funded on our balance
sheet.
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Changes in the interrelationships between various interest rates can
reduce our net interest income even in the absence of a clearly defined interest
rate trend. For instance, if the interest rate indices that drive our asset
yields were to decline relative to the interest rate indices that determine our
cost of funds, our net interest income would be reduced. As another example, if
short-term interest rates rise relative to long-term interest rates (a flatter
or inverted yield curve) then prepayments on our adjustable rate residential
loans would likely increase and this may reduce earnings.
HEDGING ACTIVITIES MAY REDUCE LONG-TERM EARNINGS AND MAY FAIL TO REDUCE EARNINGS
VOLATILITY OR TO PROTECT OUR CAPITAL IN DIFFICULT ECONOMIC ENVIRONMENTS; FAILURE
TO HEDGE MAY ALSO HAVE ADVERSE EFFECTS ON OUR RESULTS.
We attempt to hedge certain risks through managing certain characteristics
of our assets and liabilities, and as we deem appropriate, by entering into
various interest rate agreements. The amount and level of interest rate
agreements that we have may vary significantly over time. We generally attempt
to enter into interest rate hedges that provide an appropriate and efficient
method for hedging the desired risk. We may elect accounting treatment under FAS
133 for a portion of our hedges. However, there can be no assurance that
electing FAS 133 accounting for certain hedges will improve the quality of our
reported earnings or that we will continue to meet the requirements of FAS 133
when elected. In addition, the ongoing requirements of FAS 133 are complex and
rigorous; if we fail to meet these requirements we would be required to
de-designate our interest rate agreements as hedges under FAS 133 and commence
mark-to-market accounting through our consolidated statements of income.
Our quarterly earnings may reflect volatility in earnings that are
exaggerated by the resulting accounting treatment for certain hedges.
Hedging against interest rate movements using interest rate agreements
(including interest rate swap instruments and interest rate futures) and other
instruments usually has the effect over long periods of time of lowering
long-term earnings. To the extent that we hedge, it is usually to protect us
from some of the effects of short-term interest rate volatility, to lower
short-term earnings volatility, to stabilize liability costs, or to stabilize
the future cost of anticipated liability issuance. Such hedging may not achieve
its desired goals. Using interest rate agreements to hedge may increase
short-term earnings volatility, if we elect mark-to-market accounting for our
hedges. Reductions in market values of interest rate agreements may not be
offset by increases in market values of the assets or liabilities being hedged.
Conversely, increases in market values of interest rate agreements may not fully
offset declines in market values of assets or liabilities being hedged. Changes
in market values of interest rate agreements may require us to pledge
significant amounts of collateral or cash. Hedging exposes us to counter-party
risks.
We also may hedge by taking short, forward, or long positions in U.S.
treasuries, mortgage securities, or other cash instruments. Such hedges may have
special basis, liquidity, and other risks.
MAINTAINING REIT STATUS MAY REDUCE OUR FLEXIBILITY.
To maintain REIT status, we must follow rules and meet certain tests. In
doing so, our flexibility to manage our operations may be reduced. If we make
frequent asset sales to persons deemed customers, we could be viewed as a
"dealer," and thus subject to entity level taxes. Certain types of hedging may
produce non-qualifying income under the REIT rules. Our ability to own non-real
estate related assets and earn non-real estate related income is limited.
Meeting minimum REIT dividend distribution requirements may reduce our
liquidity. Because we must distribute at least 90% of our taxable REIT income as
dividends to maintain our REIT status, we may need to raise new equity capital
if we wish to grow operations at a rapid pace. Stock ownership tests may limit
our ability to raise significant amounts of equity capital from one source.
Failure to meet REIT requirements may subject us to taxation, penalties, and/or
loss of REIT status. REIT laws and taxation could change in a manner adverse to
our operations. To pursue our business plan as a REIT, we generally need to
avoid becoming a registered investment company, or RIC. To avoid RIC
restrictions, we generally need to maintain at least 55% of our assets in whole
loan form or in other related forms of assets that qualify for this test.
Meeting this test may restrict our flexibility. Failure to meet this test would
limit our ability to leverage and would impose other restrictions on our
operations. Our ability to invest in taxable subsidiaries is limited under the
REIT rules. Our REIT status affords us certain protections against take-over
attempts. These take-over restrictions may not always work to the advantage of
stockholders. Our stated goal is to not generate income that would be taxable as
unrelated business taxable income, or UBTI, to our tax-exempt stockholders.
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Achieving this goal may limit our flexibility in pursuing certain transactions.
Despite our efforts to do so, we may not be able to avoid creating or
distributing UBTI to our stockholders.
We may seek to retain a portion of our earnings from time to time so we
can increase our investments in real estate loans and securities; we will be
subject to income and excise taxes under the REIT tax rules if we do so. New tax
rules regarding dividends have been enacted and future legislative or regulatory
changes may limit the tax benefits accorded to REITs, either of which may reduce
some of a REIT's competitive edge relative to non-REIT corporations.
OUR CASH BALANCES AND CASH FLOWS MAY BECOME LIMITED RELATIVE TO OUR CASH NEEDS.
We need cash to meet our interest expense payments, working capital,
minimum REIT dividend distribution requirements, and other needs. Cash could be
required to pay-down our recourse short-term borrowings in the event that the
market values of our assets that collateralize our debt decline, the terms of
short-term debt become less attractive, or for other reasons. Cash flows from
principal repayments could be reduced should prepayments slow or should credit
quality trends deteriorate (in the latter case since, for certain of our assets,
credit tests must be met for us to receive cash flows). For some of our assets,
cash flows are "locked-out" and we receive less than our pro-rata share of
principal payment cash flows in the early years of the investment. Operating
cash flow generation could be reduced if earnings are reduced, if discount
amortization income significantly exceeds premium amortization expense, or for
other reasons. Our minimum dividend distribution requirements could become large
relative to our cash flow if our income as calculated for tax purposes
significantly exceeds our cash flow from operations. Generally, our cash flow
has materially exceeded our cash requirements; this situation could be reversed,
however, with corresponding adverse consequences to us. We generally maintain
what we believe are ample cash balances and access to borrowings to meet
projected cash needs. In the event, however, that our liquidity needs exceed our
access to liquidity, we may need to sell assets at an inopportune time, thus
reducing our earnings. In an adverse cash flow situation, our REIT status or our
solvency could be threatened.
INCREASED COMPETITION COULD REDUCE OUR ACQUISITION OPPORTUNITIES OR AFFECT OUR
OPERATIONS IN A NEGATIVE MANNER.
We believe that our principal competitors in our business of investing in
real estate loans are banks and thrifts, mortgage and bond insurance companies,
other mortgage REITs, hedge funds and private investment partnerships, life
insurance companies, government sponsored entities such as Fannie Mae, Freddie
Mac, Ginnie Mae, and the Federal Home Loan Banks, mutual funds, pension funds,
mortgage originators, Wall Street broker-dealers, overseas entities, and other
financial institutions. Although we anticipate that we will be able to compete
effectively due to our relatively low level of operating costs, relative freedom
to securitize our assets, our ability to utilize leverage, freedom from certain
forms of regulation, focus on our core business, and the tax advantages of our
REIT status, nevertheless, many of our competitors have greater operating and
financial resources than we do. Competition from these entities, or new
entrants, could raise prices on real estate loans and other assets, reduce our
acquisition opportunities, or otherwise materially affect our operations in a
negative manner. We expect competition to increase.
NEW ASSETS MAY NOT BE AVAILABLE AT ATTRACTIVE PRICES, THUS LIMITING OUR GROWTH
AND/OR EARNINGS.
In order to reinvest proceeds from real estate loan principal repayments,
or to deploy new equity capital that we may raise in the future, we need to
acquire new assets. If pricing of new assets is unattractive, or if the
availability of new assets is much reduced, we may not be able to acquire new
assets that will generate attractive returns. Our new assets may generate lower
returns than the assets that we have on our balance sheet. Generally,
unattractive pricing and availability of new assets is a function of reduced
supply and/or increased demand. Supply can be reduced if originations of a
particular product are reduced, or if there are few sales in the secondary
market of seasoned product from existing portfolios. The supply of new
securitized assets appropriate for our balance sheet could be reduced if the
economics of securitization become unattractive or if a form of securitization
that is not favorable for our balance sheet predominates. Also, assets with a
favorable risk/reward ratio may not be available if the risks of owning such
assets increase substantially relative to market pricing levels. Increased
competition could raise prices to unattractive levels.
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ACCOUNTING CONVENTIONS AND ESTIMATES CAN CHANGE, AFFECTING OUR REPORTED RESULTS
AND OPERATIONS.
Accounting rules for the various aspects of our business change from time
to time. Changes in accounting rules or the accepted interpretation of these
rules can affect our reported income, earnings, and stockholders' equity. Our
revenue recognition and other aspects of our reported results are based on
estimates of future events. These estimates can change in a manner that
adversely affects our results or demonstrate, in retrospect, that revenue
recognition in prior periods was too high or too low.
OUR POLICIES, PROCEDURES, PRACTICES, PRODUCT LINES, RISKS, HEDGING PROGRAMS, AND
INTERNAL RISK-ADJUSTED CAPITAL GUIDELINES ARE SUBJECT TO CHANGE.
In general, we are free to alter our policies, procedures, practices,
product lines, leverage, risks, internal risk-adjusted capital guidelines, and
other aspects of our business. We can enter new businesses or pursue
acquisitions of other companies. In most cases, we do not need to seek
stockholder approval to make such changes. We will not necessarily notify
stockholders of such changes.
WE DEPEND ON KEY PERSONNEL FOR SUCCESSFUL OPERATIONS.
We depend significantly on the contributions of our executive officers and
staff. Many of our officers and employees would be difficult to replace. The
loss of any key personnel could materially affect our results.
INVESTORS IN OUR COMMON STOCK MAY EXPERIENCE LOSSES, VOLATILITY, AND POOR
LIQUIDITY, AND WE MAY REDUCE OUR DIVIDENDS IN A VARIETY OF CIRCUMSTANCES.
Our earnings, cash flow, book value, and dividends can be volatile and
difficult to predict. Investors should not rely on predictions or management
beliefs. Although we seek to pay a regular common stock dividend rate that is
sustainable, we may reduce our dividend rate in the future for a variety of
reasons. We may not provide public warnings of such dividend reductions prior to
their occurrence. Fluctuations in our current and prospective earnings, cash
flow, and dividends, as well as many other factors such as perceptions, economic
conditions, stock market conditions, and the like, can affect our stock price.
Investors may experience volatile returns and material losses. In addition,
liquidity in the trading of our stock may be insufficient to allow investors to
sell their stock in a timely manner or at a reasonable price.
S-14
USE OF PROCEEDS
The net proceeds that we will receive from the sale of 1,050,000 shares of
our common stock in this offering are estimated to be approximately $45.5
million, after deducting underwriting discounts and commissions and estimated
expenses, assuming the over-allotment option is not exercised by the
underwriter, and $52.0 million assuming the over-allotment option is exercised
in full. We intend to use the net proceeds, together with borrowings, to
purchase new assets, substantially all of which we expect will be real estate
loan assets. Pending use of the net proceeds to purchase such assets, the net
proceeds will be used to reduce short-term collateralized borrowings. These
borrowings generally bear interest at rates that adjust based on the one-month
or six-month London Inter-Bank Offered Rate, or LIBOR, and are secured by assets
owned by us or one of our financing trusts.
PRICE RANGE OF COMMON STOCK AND DIVIDENDS
The following table sets forth the high and low sales prices of our common
stock as reported by the New York Stock Exchange as well as the cash dividends
we declared on each share for the periods indicated through May 13 2004.
PRICE RANGE COMMON DIVIDENDS DECLARED
--------------- ------------------------------
HIGH LOW PER SHARE DIVIDEND TYPE
------ ------ -------------- -------------
2002
First quarter.................. $27.49 $23.76 $0.62 Regular
Second quarter................. $31.50 $27.00 $0.63 Regular
$0.125 Special
Third quarter.................. $31.45 $23.00 $0.63 Regular
$0.125 Special
Fourth quarter................. $28.20 $23.54 $0.63 Regular
$0.125 Special
2003
First quarter.................. $33.15 $27.25 $0.65 Regular
Second quarter................. $42.75 $32.15 $0.65 Regular
Third quarter.................. $44.12 $34.70 $0.65 Regular
Fourth quarter................. $58.25 $41.14 $0.65 Regular
$4.75 Special
2004
First quarter.................. $63.47 $47.72 $0.67 Regular
$0.50 Special
Second quarter (through May 13,
2004)....................... $62.71 $42.73 $0.67 Regular
S-15
COMMON STOCK DIVIDEND POLICY AND DISTRIBUTIONS
We intend to distribute at least 90% of the taxable income that we earn to
our stockholders so as to comply with the REIT tax rules. Our taxable income
does not equal net income as calculated for GAAP. We do not intend to distribute
as dividends the taxable income we earn in our non-REIT subsidiaries. We
currently declare regular quarterly dividends. Our goal is to pay dividends on
our common stock at a rate that is steady and sustainable given the levels of
cash flow we expect to generate from our REIT operations over time. In May 2004,
our Board of Directors declared a regular cash dividend of $0.67 per share,
payable on July 21, 2004 for stockholders of record on June 30, 2004. Based upon
our current outlook, we believe that our cash flows will be sufficient to
sustain dividend payments at the rate of at least $0.67 per share per quarter
for the reasonably foreseeable future. Please see "Risk Factors" for a
discussion of some of the factors that could potentially lead to a lower
dividend rate. We have increased our dividend rate over the last few years as
our profits and cash flows have increased. Our Board of Directors will consider
additional increases to our regular dividend rate in the event that our current
business initiatives successfully increase our expected long-term rate of
profitability and cash flows.
In certain years, our Board of Directors may declare one or more special
dividends in order to meet the annual minimum dividend distribution requirements
necessary to comply with the REIT tax rules. In 2003, our Board of Directors
declared a special cash dividend totaling $4.75 per share. In 2003, the total
common stock dividends declared, including regular dividends and the special
dividend, was $7.35. In March 2004, our Board of Directors declared another
special cash dividend of $0.50 per share, which was paid on April 21, 2004 to
stockholders of record on March 31, 2004.
The dividend policy with respect to our common stock is subject to
revision at the discretion of our Board of Directors. All distributions will be
made by us at the discretion of our Board of Directors and will depend on our
REIT taxable income, maintaining our REIT status, GAAP earnings, cash flows and
overall financial condition, and such other factors as our Board of Directors
deems relevant.
Distributions to our stockholders will generally be subject to tax as
ordinary income, although a portion of such distributions may be designated by
us as capital gain or may constitute a tax-free return of capital. Our Board of
Directors may elect to maintain a steady dividend rate during periods of
fluctuating taxable income. In such event, our Board of Directors may choose to
declare dividends that include a return of capital. We will annually furnish to
each stockholder a statement setting forth distributions paid during the
preceding year and their characterization as ordinary income, capital gains or
return of capital. For a discussion of the federal income tax treatment of our
distributions, see "Federal Income Tax Considerations -- Taxation of
Stockholders" in this prospectus supplement.
S-16
CAPITALIZATION
The following table sets forth our capitalization as of March 31, 2004 (i)
on an actual basis, and (ii) as adjusted for the issuance of 1,050,000 shares of
our common stock offered hereby. See "Use of Proceeds." The capitalization
information set forth in the table below is qualified by the more detailed
Consolidated Financial Statements and Notes thereto included in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2003 and our Form
10-Q for the quarter ended March 31, 2004.
MARCH 31, 2004
-----------------------------
ACTUAL(1)(2) AS ADJUSTED(3)
------------ --------------
UNAUDITED
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
STOCKHOLDERS' EQUITY:
Common Stock, par value $0.01 per share; 50,000,000 shares
authorized; 19,796,237 issued and outstanding, actual;
20,846,237 shares issued and outstanding, as
adjusted(3)............................................... $ 198 $ 208
Additional paid-in capital.................................. 548,662 594,114
Accumulated other comprehensive income...................... 78,517 78,517
Cumulative earnings......................................... 299,763 299,763
Cumulative distributions to stockholders.................... (319,018) (319,018)
--------- ---------
Total stockholders' equity........................ $ 608,122 $ 653,584
========= =========
- ------------
(1) Excludes as of March 31, 2004 (i) 1,648,843 shares of common stock issuable
upon exercise of outstanding options at a weighted average exercise price of
$28.56 per share and (ii) an aggregate of 126,724 shares available for
future issuance under our Stock Option Plan.
(2) At March 31, 2004, we also utilized borrowings of $277.9 million of
short-term debt and $18.6 billion of long-term debt, net.
(3) Adjusted for the issuance of 1,050,000 shares offered hereby, with net
proceeds of approximately $45.5 million after underwriting discounts,
commissions and other estimated expenses. Assumes no exercise of the
underwriter's over-allotment option.
S-17
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE DATA)
The following selected consolidated financial data should be read in
conjunction with "Selected Financial Data", "Management's Discussion and
Analysis of Financial Condition and Results of Operations", and our Consolidated
Financial Statements and the related Notes included in our Annual Report on Form
10-K for the fiscal year ended December 31, 2003 and our Quarterly Report on
Form 10-Q for the quarter ended March 31, 2004.
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------------------- -------------------------
CONSOLIDATED STATEMENTS OF 2003 2002 2001 2004 2003
INCOME DATA: ----------- ----------- ----------- ----------- -----------
INTEREST INCOME
Residential real estate loans........... $ 244,124 $ 98,745 $ 65,779 $ 101,337 $ 44,070
Residential loan credit-enhancement
securities............................ 68,091 37,427 16,683 15,533 13,693
Commercial real estate loans............ 3,459 5,000 7,480 701 816
Securities portfolio.................... 23,530 24,404 54,257 9,611 4,192
Cash and cash equivalents............... 418 948 1,107 166 110
----------- ----------- ----------- ----------- -----------
Interest income before provision for
credit losses......................... 339,622 166,524 145,306 127,348 62,881
Provision for credit losses............. (8,646) (3,308) (767) (2,511) (1,756)
----------- ----------- ----------- ----------- -----------
Total interest income................... 330,976 163,216 144,539 124,837 61,125
INTEREST EXPENSE
Short-term debt......................... (7,038) (20,312) (40,401) (2,571) (1,940)
Long-term debt.......................... (195,823) (71,393) (57,668) (77,006) (34,993)
----------- ----------- ----------- ----------- -----------
Total interest expense.................. (202,861) (91,705) (98,069) (79,577) (36,933)
NET INTEREST INCOME..................... 128,115 71,511 46,470 45,260 24,192
Operating expenses...................... (36,895) (20,005) (12,747) (10,026) (8,282)
Net recognized gains and valuation
adjustments........................... 46,676 5,111 1,532 17,437 918
----------- ----------- ----------- ----------- -----------
Net income before provision for income
taxes................................. 137,896 56,617 35,255 52,671 16,828
Provision for income taxes.............. (5,502) -- -- (1,880) (1,215)
----------- ----------- ----------- ----------- -----------
Net Income before change in accounting
principle............................. 132,394 56,617 35,255 50,791 15,613
Cumulative effect of adopting EITF
99-20................................. -- -- (2,368) -- --
----------- ----------- ----------- ----------- -----------
Net Income.............................. 132,394 56,617 32,887 50,791 15,613
Dividends on Class B preferred stock.... (681) (2,724) (2,724) -- (681)
----------- ----------- ----------- ----------- -----------
NET INCOME AVAILABLE TO COMMON
STOCKHOLDERS.......................... $ 131,713 $ 53,893 $ 30,163 $ 50,791 $ 14,932
=========== =========== =========== =========== ===========
EARNINGS PER SHARE:
Basic earnings per share:
Net income before change in accounting
principle............................. $ 7.42 $ 3.55 $ 3.20 $ 2.61 $ 0.91
Cumulative effect of adopting EITF
99-20................................. -- -- (0.23) -- --
----------- ----------- ----------- ----------- -----------
Net income available to common
stockholders.......................... $ 7.42 $ 3.55 $ 2.97 $ 2.61 $ 0.91
Diluted earnings per share:
Net income before change in accounting
principle............................. $ 7.09 $ 3.44 $ 3.11 $ 2.49 $ 0.88
Cumulative effect of adopting EITF
99-20................................. -- -- (0.23) -- --
----------- ----------- ----------- ----------- -----------
Net income available to common
stockholders.......................... $ 7.09 $ 3.44 $ 2.88 $ 2.49 $ 0.88
----------- ----------- ----------- ----------- -----------
Dividends declared per preferred
share................................. $ 0.755 $ 3.020 $ 3.020 $ -- $ 0.755
Dividends declared per common share..... $ 7.350 $ 2.885 $ 2.550 $ 1.170 $ 0.650
Weighted average shares of common stock
and common stock equivalents:
Basic................................... 17,759,346 15,177,449 10,163,581 19,427,373 16,412,867
Diluted................................. 18,586,649 15,658,623 10,474,764 20,398,644 16,983,513
S-18
DECEMBER 31, DECEMBER 31, MARCH 31,
2003 2002 2004
CONSOLIDATED BALANCE SHEETS DATA: ------------ ------------ -----------
ASSETS
Residential real estate loans............................. $16,239,160 $6,215,179 $18,086,505
Residential loan credit-enhancement securities............ 378,727 352,479 374,616
Commercial real estate loans.............................. 22,419 29,270 22,177
Securities portfolio...................................... 844,714 335,697 936,646
Cash and cash equivalents................................. 58,467 39,169 57,866
----------- ---------- -----------
Total earning assets............................... 17,543,487 6,971,794 19,477,810
Restricted cash........................................... 21,957 11,755 14,207
Accrued interest receivable............................... 39,706 19,087 44,343
Principal receivable...................................... 13,743 1,214 477
Other assets.............................................. 7,877 3,922 6,736
----------- ---------- -----------
TOTAL ASSETS.............................................. $17,626,770 $7,007,772 $19,543,573
=========== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt........................................... $ 236,437 $ 99,714 $ 277,910
Long-term debt, net....................................... 16,782,586 6,397,020 18,583,030
Accrued interest payable.................................. 16,556 5,267 17,924
Accrued expenses and other liabilities.................... 25,472 19,768 33,425
Dividends payable......................................... 12,391 12,970 23,162
----------- ---------- -----------
Total Liabilities.................................. 17,073,442 6,534,739 18,935,451
----------- ---------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74%
Cumulative Convertible, 0, 902,068 and 0 shares
authorized, issued, and outstanding ($0, $28,645 and $0
aggregate liquidation preference)....................... -- 26,517 --
Common stock, par value $0.01 per share; 50,000,000,
49,097,932 and 50,000,000 shares authorized; 19,062,983,
16,277,285, 19,796,237 issued and outstanding........... 191 163 198
Additional paid-in capital................................ 517,826 418,701 548,662
Accumulated other comprehensive income.................... 82,179 69,146 78,517
Cumulative earnings....................................... 248,972 116,578 299,763
Cumulative distributions to stockholders.................. (295,840) (158,072) (319,018)
----------- ---------- -----------
Total Stockholders' Equity......................... 553,328 473,033 608,122
----------- ---------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................ $17,626,770 $7,007,772 $19,543,573
=========== ========== ===========
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------------------- -------------------------
2003 2002 2001 2004 2003
CASH FLOW DATA: ------------ ----------- --------- ----------- -----------
Net income available to common
stockholders............................. $ 131,713 $ 53,893 $ 30,163 $ 50,791 $ 14,932
Preferred dividends........................ 681 2,724 2,724 -- 681
------------ ----------- --------- ----------- -----------
Net income available before preferred
dividends................................ 132,394 56,617 32,887 50,791 15,613
Adjustments to reconcile net income to net
cash (used in) provided by operating
activities............................... (63,156) (1,114,029) (404,853) (20,649) 4,261
------------ ----------- --------- ----------- -----------
Net cash provided by (used in) operating
activities............................... 69,238 (1,057,412) (371,966) 30,142 19,874
Net cash (used in) provided by investing
activities............................... (10,506,606) (3,343,950) 66,179 (1,910,472) (1,160,654)
------------ ----------- --------- ----------- -----------
Net cash provided by financing
activities............................... 10,456,666 4,431,501 299,334 1,879,729 1,144,493
Net increase (decrease) in cash and cash
equivalents.............................. 19,298 30,139 (6,453) (601) 3,713
------------ ----------- --------- ----------- -----------
Cash and cash equivalents at beginning of
period................................... 39,169 9,030 15,483 58,467 39,169
Cash and cash equivalents at end of
period................................... $ 58,467 $ 39,169 $ 9,030 $ 57,866 $ 42,882
Supplemental disclosure of cash flow
information:
Cash paid for interest..................... $ 191,572 $ 89,007 $ 100,919 $ 52,472 $ 36,428
Cash paid for taxes........................ $ 7,006 $ 0 $ 0 $ 880 $ 63
Non-financing activity:
Dividends declared but not paid............ $ 12,391 $ 12,970 $ 8,278 $ 23,162 $ 11,474
S-19
COMPANY BUSINESS AND STRATEGY
GENERAL
Our business model and principal strategy are based on our belief that an
efficiently structured financial company can achieve consistent growth and
profitability though disciplined investing in owning and credit-enhancing
high-quality jumbo residential real estate loans -- those loans outside the
reach of Fannie Mae and Freddie Mac, the two U.S. government-sponsored
residential real estate loan investors. Our primary goal is to generate steady
income and dividends for our stockholders.
OUR INDUSTRY
There are approximately $7.1 trillion of residential real estate loans
outstanding in the United States. The amount outstanding has grown at an average
rate of 9% per year for approximately 20 years as home ownership and housing
values have generally increased. New originations of residential real estate
loans have ranged from $1.0 trillion to $3.8 trillion per year over the last
five years. Originations generally increase in years when refinancing activity
is stronger due to declines in long-term interest and mortgage rates.
The U.S. government-sponsored residential real estate loan investment
companies, Fannie Mae and Freddie Mac, are prohibited from owning and
credit-enhancing real estate loans with balances over certain limits (the limit
for single-family real estate loans originated within the continental United
States is currently $333,700). Loans with balances larger than this limit are
commonly referred to as jumbo loans. We estimate that over the past five years,
new originations of jumbo residential real estate loans have ranged between $200
billion and $700 billion per year making up between 18% and 22% of total new
residential loan originations. We believe that outstanding jumbo residential
real estate loans total over $1.4 trillion. We also believe that the outstanding
balance of jumbo residential real estate loans will continue to grow at the same
rate as the residential loan market as a whole (between 4% and 12% per year).
Each year the amount of jumbo loans that are available for sale consists
of new originations plus seasoned loans that are sold into the secondary
mortgage market by financial institutions from their portfolio, less loans that
are retained by originators for their own portfolios. The amount of jumbo loans
for sale each year depends on the economic conditions and other factors that
determine the level of new loan originations and the relative attractiveness to
financial institutions of selling versus retaining loans.
Historically, jumbo residential real estate loans that are available for
sale have been purchased by financial institutions such as banks and thrifts
that want to increase their loan portfolios to a size that is larger than they
can achieve through retaining all their own loan production. These institutions
fund their loan investment activities with deposits and other borrowings.
Increasingly, since the mid-1980s, jumbo residential real estate loans have been
funded through the creation and sale of mortgage-backed securities to the
capital markets. We estimate that the share of jumbo residential real estate
loans outstanding that have been securitized has been increasing steadily from
approximately 10% in 1990 to over 50% in 2003. We believe that loan
securitization has become the financing method of choice in the jumbo loan
market because securitization is generally a more efficient form of funding than
deposits or other borrowings.
Jumbo residential real estate loan securitizations may consist of seasoned
loans or newly originated loans. Seasoned loan securitizations generally contain
loans that are being sold from the retained mortgage portfolios of the larger
banks and thrifts. Securitizations of new originations generally contain loans
sold by the larger originators of jumbo mortgage loans or by conduits. Conduits
acquire individual loans or small loan portfolios in order to aggregate loan
pools for securitization.
Substantially all of the demand for mortgage-backed securities comes from
investors that desire to hold the cash flows of a residential real estate loan
but are not able or willing to build the operations necessary to manage the
credit risk of real estate loans. These investors demand that mortgage-backed
securities be rated investment-grade by the credit rating agencies. In order to
create investment-grade mortgage-backed securities from a pool of residential
real estate loans, credit enhancement for those loans must be provided so that
someone other than the investment-grade security buyer assumes the credit risk.
In a securitization, a pool of residential real estate loans can be
credit-enhanced through a number of different methods. The senior/subordinated
structure is currently the most prevalent method for credit-enhancement of jumbo
residential real estate loans. This structure establishes a set of senior
security interests in the pool of real estate loans and a set of subordinated
(junior) security interests in the pool. The subordinated
S-20
interests are acquired by one or more entities that provide credit-enhancement
to the underlying real estate loans. Credit losses in the loan pool reduce the
principal of the subordinated interests first, thus providing some credit
protection to the senior securities that allows them to be rated investment
grade. Other forms of credit-enhancement, such as pool insurance provided by
mortgage insurance companies, bond insurance provided by bond insurance
companies, and corporate guarantees are often less efficient than the
senior/subordinated structure due to regulation and rating agency requirements,
among other factors.
Credit enhancers of jumbo residential real estate loan securitizations
profit from cash flows generated from the ownership of the subordinated
credit-enhancement interests. The amount and timing of credit losses in the
underlying loan pools affect the yields generated by these assets. These
interests are generally purchased at a discount to the principal value of the
interest, and much of the potential return to the subordinated investor is
generated through the ultimate return of the principal that remains after
realized credit losses are deducted.
The business of enabling the securitization of jumbo residential real
estate loans by assuming the credit risk on the loans is highly fragmented.
Credit enhancers of jumbo residential loan securitizations include banks and
thrifts (generally credit-enhancing their own loan originations), insurance
companies, Wall Street broker-dealers, hedge funds, private investment firms,
mortgage REITs, and others.
The liquidity crisis in the financial markets in 1998 caused many of the
participants in this market to withdraw. With reduced demand stemming from
reduced competition, and increased supply as a result of increased originations
and sales of seasoned loan portfolios, prices of residential credit-enhancement
interests declined and the acquisition of these interests became more
attractive. Prices further declined in 1999 as financial turmoil continued and
many financial institutions reorganized themselves to focus on other businesses.
From 1998 through 2002, the prices of assets and the margins available in
the jumbo residential credit-enhancement business were generally attractive. In
2003, while the supply of credit-enhancement securities generally increased as a
result of an increase in jumbo real estate loan securitizations, there was a
general increase in competition, demand, and prices in this market. We believe
that we will continue to experience increased competition and that reduced
supply is likely in the next few years which will continue to negatively affect
prices.
OUR COMPANY
Over the past ten years, we have built a company that allows us to compete
effectively in the business of investing, owning, and credit enhancing
high-quality jumbo residential real estate loans in the United States. The key
aspects of our business model are as follows:
Focus. We target the ownership and credit-enhancement of jumbo residential
real estate loans as our primary business. Our specialty is acquiring jumbo
residential real estate loans and funding these acquisitions through
securitizations. We also specialize in acquiring credit-enhancement securities
that facilitate the securitizations of third parties. We believe securitizations
are an efficient form of financing jumbo residential real estate loans and have
advantages over the typical funding methods used by depository institutions such
as banks and thrifts. By focusing on funding our investments through
securitizations, we believe our long-term growth opportunities will continue to
be attractive. We believe that opportunities will be particularly attractive if
an increasing share of jumbo residential real estate loans is securitized and if
the jumbo residential real estate loan market as a whole continues to grow at
historical rates.
Emphasis on long-term asset portfolio. Through our operations, we seek to
structure and build a unique portfolio of valuable real estate loan assets. We
seek to structure long-term assets with expected average lives of five to ten
years. The long-term nature of these assets helps to reduce reinvestment risk
and generally provides us with more stable, proprietary cash flows that help
support our goal of maintaining steady dividends over time.
Specialized expertise and scalable operations. We believe we have
developed all of the specialized expertise necessary to efficiently and
economically invest in and credit enhance jumbo residential real estate loans.
Our accumulated market knowledge, relationships with mortgage originators and
others, sophisticated risk-adjusted capital policies, strict underwriting
procedures, and successful experience with shifting financial market conditions
allow us to acquire and securitize real estate loans and effectively manage the
risks inherent with those businesses. We build and maintain relationships with
large mortgage originators, banks that are likely to sell real estate loan
portfolios, Wall Street investment firms that broker real estate loans and
securities, and the buyers of our securitization bonds. We continue to develop
our staff, our analytics, our models, and other
S-21
capabilities that help us structure securitization transactions and cash flows,
evaluate credit quality of individual loans and pools of loans, underwrite loans
effectively, and monitor trends in credit quality and expected losses in our
existing portfolios. We establish relationships with our servicing companies to
assist with monthly surveillance, loss mitigation efforts, delinquent loan
work-out strategies, and REO liquidation. Aside from collaborating with our
servicers on these issues, we insist that specific foreclosure timelines are
followed and that representations and warranties made to us by sellers are
enforced. For balance sheet management, we work to project cash flows and
earnings, determine capital requirements, source borrowings efficiently,
preserve liquidity, and monitor and manage risks effectively.
Even as we continue to enhance our capabilities, we believe that our
operations are scalable. In the long run, we do not expect our operating costs
to grow at the same rate as our net interest income should we expand our capital
base and our portfolios. Thus, other factors being equal, we believe that growth
in our capital could be materially accretive to earnings and dividends per
share.
Competitive advantage of our corporate structure. As a REIT, we pay only
limited income taxes, traditionally one of the largest costs of doing business.
In addition, we are not subject to the extensive regulations applicable to
banks, thrifts, insurance companies, and mortgage banking companies; nor are we
subject to the rules governing regulated investment companies. We believe the
absence of business-restrictive regulations in our market sector is a
competitive advantage. The regulations applicable to certain financial companies
can cause capital inefficiencies and higher operating costs for certain of our
competitors. Our structure enables us to acquire attractive investments that are
not feasible or practical for other financial companies.
Flexibility in real estate loan portfolio orientation. We are open to
other areas of opportunity within real estate finance and related fields that
may compliment and benefit our core business activity of investing in jumbo
residential real estate loans. In addition to our jumbo residential loan
operations, we currently invest in commercial real estate loans and in
securities collateralized by diverse types of residential and commercial real
estate loans. Depending on the relative attractiveness of the opportunities in
these or new product lines, we may increase or decrease the size of and capital
allocation to these portfolios over time.
We also generally look for investment opportunities that fit our value
orientation, that take advantage of the unusual structural characteristics of
our balance sheet, and that allow us to develop an advantage over many of our
competitors.
OUR STRATEGY
Our objective is to produce attractive earnings and dividend growth for
stockholders, primarily through investing in, owning and credit enhancing
high-quality jumbo residential real estate loans and other real estate loans and
securities.
The key aspects of our strategy are as follows:
Preserve portfolio quality. In our experience, the highest long-term
risk-adjusted returns come from owning and credit enhancing highest quality real
estate loans. For this reason, we have focused on acquiring "A quality" or
"prime quality" jumbo residential real estate loans. Within the prime real
estate loan category, there are degrees of quality: "A", "Alt-A", and "A minus."
As compared to the market as a whole, we believe our portfolio is generally
concentrated in the top quality end of the "A" residential real estate loan
category.
We generally own and credit enhance residential real estate loans from
large, high-quality, national mortgage origination companies. We also have some
of the highest quality servicing companies processing our loan payments and
assisting with loss mitigation. While we may acquire or credit enhance loans
that are less than "A" quality, we currently intend to do so only for seasoned
loans of this type that may have less risk than newly-originated loans. We also
may own A-minus, Alt-A, and sub-prime residential real estate loan securities
that, for the most part, are rated investment-grade because they are credit
enhanced in some form by others, which mitigates our risk of credit-loss from
these securities.
Maintain geographic diversity. With respect to geography, our jumbo
residential real estate loan portfolio is approximately as diverse as the U.S.
jumbo residential real estate loan market as a whole. We own and credit enhance
loans in all 50 states. With the exception of California, no one state generally
represents more than 5% of our portfolio. Our exposure to California loans is
approximately 50%, about the same percentage as the total
S-22
jumbo residential real estate loans outstanding in the United States. Less than
1% of the jumbo loans we own and credit enhance are in any one zip code in the
United States.
Match-fund effectively. In the course of our business, we do not generally
seek to put ourselves in a position where the anticipation of specific interest
rates or loan prepayment rates is material to meeting our long-term goals.
Accordingly, we generally attempt to match the interest rate, prepayment rate,
and cash flow characteristics of our on-balance sheet assets to our liabilities.
Currently, our assets are funded through securitizations that generally match
the interest rate and prepayment characteristics of the assets (i.e., our
adjustable rate assets are funded with floating rate securities, fixed rate
assets with fixed rate securities, etc.). Any amount of unhedged or unmatched
hybrid and fixed rate assets we own generally does not materially exceed our
equity base. We use interest rate agreements to help us achieve our desired
asset/liability mix and we anticipate continuing to use these interest rate
agreements in the future. Although our assets and liabilities are effectively
match-funded, some variation in earnings may still result from changes in
short-term interest rates.
Manage capital levels. We manage our capital levels, and thus our access
to borrowings and liquidity, through risk-adjusted capital policies supervised
by our senior executives. We believe these conservative and well-developed
guidelines are an important tool that helps us achieve our goals and mitigate
the risks of our business. We continually seek to improve the effective use of
our capital without changing our underlying goals and policies. Through these
policies, we believe we effectively assign a capital adequacy guideline amount
and maintain sufficient cash to appropriately manage our capital needs. In most
circumstances in which our actual capital levels decreased below our capital
adequacy guideline amount, we would expect to cease the acquisition of new
assets until capital guideline levels were restored through loan prepayments,
asset sales, securitization transactions, capital raising, or other means.
Our current plan is to use securitization, accounted for as the issuance
of long-term securitized non-recourse debt, to fund our real estate assets and
restrict our use of short-term recourse debt to the temporary funding of assets
under accumulation for securitization. To the extent that we do have real estate
assets funded with short-term recourse debt that is subject to margin calls, our
capital requirement guidelines will fluctuate over time, based on changes in the
short-term funded asset's credit quality, liquidity characteristics, potential
for market value fluctuation, interest rate risk, prepayment risk and the
over-collateralization requirements for that asset set by our collateralized
short-term lenders. We typically fund our residential credit-enhancement
securities and our retained interests from our securitizations with equity. The
size of our retained interest in our securitizations relative to the amount of
assets underlying that securitization generally depends on the determination of
the credit rating agencies with respect to the amount of credit enhancement
necessary to create investment-grade bonds to be issued from the securitization.
Retained interests generally range from 0.2% to 2.0% of high-quality residential
real estate loans, from 1% to 7% of re-securitized real estate loan securities,
and from 5% to 30% of commercial real estate loans.
Pursue growth. We are pursuing a long-term growth strategy, seeking to
increase the amount of equity capital we have employed in our business of
investing in real estate loans. As we increase our equity, we believe we will be
able to strengthen our relationships with our customers from whom we buy real
estate assets, thus potentially giving us certain pricing, cost, and other
competitive advantages. As we increase the size of our capital base, we believe
that we may benefit from improved operating expense ratios, lower borrowing
expenses, improved capital efficiencies, and related factors that may improve
earnings and dividends per share. In order to continue to grow, we have been
expanding our capabilities and financing arrangements to allow us to increase
our investment in commercial real estate loans and diverse residential and
commercial real estate loan securities. We believe any new product areas we
pursue will provide us with diversification of both risk and opportunity.
OUR REAL ESTATE LOAN ASSETS
We have four portfolios of real estate loan investments: residential real
estate loans, residential real estate loan credit-enhancement securities,
commercial real estate loans, and securities portfolio (consisting of diverse
residential and commercial real estate securities, primarily investment-grade).
Each of these portfolios is a component of our single business segment of
investing in real estate loans. Our current intention is to focus on investing
in and managing these four existing portfolios. We manage our real estate loan
investments as a single business segment, with common staff and management,
intermingled financing arrangements, and flexible capital allocations.
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RESIDENTIAL LOAN REAL ESTATE LOANS
We acquire high-quality jumbo residential real estate loans and hold them
as a long-term investment. We generally fund these acquisitions with our equity
and through securitizations, which are accounted for as long-term debt, that
closely matches the interest rate, prepayment, and maturity characteristics of
the loans. We show on our balance sheet both the underlying residential real
estate loans that we have securitized and the securities that we issue to fund
the loans.
The net interest income we earn from these assets equals the interest
income we earn on our loans, less expenses related to
- interest (including issuance fees) and hedging costs on
securitizations and borrowings;
- amortization of premiums paid in excess of the principal upon
acquisition of the loans; and
- credit provision incurred to provide for the appropriate credit
reserves for credit losses.
The process of adding to our residential real estate loan portfolio
commences when we underwrite and acquire residential real estate loans from
sellers. We generally seek to quickly build a portfolio large enough, at least
$200 million, to support an efficient securitization. We source our loan
acquisitions primarily from large, well-established mortgage originators and the
larger banks and thrifts.
We are always seeking bulk purchases of residential whole loan portfolios
that meet our acquisition criteria and that are priced attractively relative to
our funding costs in connection with a securitization. In addition, we acquire
new loans on a continuous or "flow" basis from originators that have loan
programs that meet our desired quality and loan type standards.
We initially fund our residential loan acquisitions with short-term debt.
When we are ready to securitize the loans, we contribute these loans to one of
our wholly owned, special purpose entity securitization subsidiaries (Sequoia
Mortgage Funding Corporation or Sequoia Residential Funding, Inc.). Sequoia
Mortgage Funding Corporation or Sequoia Residential Funding, Inc., through a
trust, then issues mostly investment grade rated mortgage-backed securities that
generally match the interest rate, prepayment, and maturity characteristics of
the loans and remits the net proceeds of the applicable offering back to us. Our
net investment equals our basis in the loans, less the net proceeds that we
received from the sale of securities. The amount of equity that we invest in
these trusts to support our securities issuance is determined by the credit
rating agencies, based on their review of the loans and the structure of the
transaction.
We plan to accumulate more high-quality jumbo residential loans when loans
are available on attractive terms relative to our anticipated costs of
securitization. We currently focus on only adjustable rate real estate loans,
but may also from time to time invest in hybrid or fixed rate loans. We may also
acquire and securitize home equity lines of credit.
RESIDENTIAL LOAN CREDIT-ENHANCED SECURITIES
In addition to investing in residential real estate loans, we also credit
enhance pools of high-quality jumbo residential loans that have been securitized
by others. We do this by acquiring subordinated securities in third-party
securitizations. These credit-enhancement securities bear the bulk of the
potential credit risk for the securitized pool of loans in order for the more
senior securitized interests to qualify for investment grade ratings for
efficient sale into the capital markets.
Generally, we acquire credit-enhancement securities from leading
high-quality national mortgage origination firms and certain other smaller firms
that specialize in high-quality jumbo residential real estate loan originations.
We also work with large banks that are sellers of seasoned portfolios of
high-quality jumbo residential real estate loans. We either work directly with
these customers or we work in conjunction with an investment bank on these
transactions. Our credit-enhancement securities are backed by fixed rate,
hybrid, and adjustable rate residential real estate loans.
The principal value of the credit-enhancement securities in any rated
senior/subordinated securitization is determined by the credit rating agencies:
Moody's Investors Service, Standard & Poor's Rating Services, and Fitch Ratings.
These credit agencies examine each pool of residential real estate loans in
detail. Based on their review of individual loan characteristics, they determine
the credit enhancement levels necessary to award investment grade ratings to the
bulk of the securities formed from these loans.
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Our actual investment, and our risk, is less than the principal value of
our credit-enhancement securities since we acquire these interests at a discount
to principal value. A portion of this discount we designate as our credit
protection for future losses; the remainder we amortize into income over time.
Our first defense against credit loss is the quality of the residential
real estate loans we acquire or otherwise credit enhance. Our loans are
generally in the high-quality range for loan factors such as loan-to-value
ratios, debt-to-income ratios, credit quality of the borrower, and completeness
of documentation. Our loans are secured by the borrowers' homes. Compared to
most corporate and consumer loans, the residential real estate loans that we
credit enhance have a much lower loss frequency and a much lower loss severity
(the severity is the percentage of the loan principal and accrued interest that
we lose upon default).
Our exposure to credit risks of the residential real estate loans that we
credit enhance is further limited in a number of respects as follows:
Risk tranching. A typical residential real estate loan securitization has
three credit-enhancement interests: a "first loss" security, a "second loss"
security, and a "third loss" security. Our first loss security investments are
directly exposed to the risk of principal loss on any loan in the underlying
loan pool that may default. Our second loss securities are exposed to credit
loss if cumulative pool losses exceed the remaining principal value of the first
loss security. Our third loss securities are exposed to loss if cumulative pool
losses exceed the remaining principal value of both the first and second loss
security. Thus, not all our investments in credit-enhancement securities are
immediately exposed to loss, and to the extent a third-party owns a first loss
security or another security that is junior to the security we own, we benefit
from the credit enhancement provided by others.
Limited maximum loss. Our potential credit exposure to the residential
real estate loans that we credit enhance is limited to our investment in the
credit-enhancement securities that we acquire.
Credit protection established at acquisition. We acquire
credit-enhancement interests at a discount to their principal value. We book a
portion of this discount as credit protection against future credit losses. For
many economic circumstances, we believe that this protection should be large
enough to absorb future losses. We establish the amount of our credit protection
at acquisition and adjust it over time following a review of the underlying
collateral, economic conditions, and other factors. If future credit results are
favorable, we may not need all of the amounts designated as credit protection.
In such event, we may then redesignate some of these balances as a discount to
be amortized into income over time. If future credit results are worse than
previously anticipated, we may need to increase the amount of designated credit
protection which could result in an immediate negative impact on earnings.
Mortgage insurance. A small portion of our credit enhanced portfolio
consists of residential real estate loans with initial loan-to-value, or LTV,
ratios in excess of 80%. For the vast majority of these higher LTV ratio loans,
we benefit from primary mortgage insurance provided on our behalf by the
mortgage insurance companies or from pledged asset accounts. Thus, for what
would otherwise be our most risky mortgage loans, we have passed much of the
risk on to third parties and our effective LTV ratios on these loans are lower
than 80%.
Representations and warranties. As the credit enhancer of a residential
real estate loan securitization, we benefit from representations and warranties
received from the sellers of the loans. In limited circumstances, the sellers
are obligated to repurchase delinquent loans from our credit enhanced pools,
thus reducing our potential exposure.
We believe that the outlook for investing in new jumbo residential real
estate credit-enhancement securities is reasonably favorable. A reasonable
supply of investment opportunities in these securities is expected to continue
even if securitization volume drops and competition for such securities
increases. Although pricing for these assets has increased in recent quarters,
we expect we can continue to find investment opportunities for these securities
at prices sufficient to generate attractive long-term returns. In general, we
expect house prices to increase over time (thus reducing our credit risk on our
loans) because the restrictions on new construction and the lack of raw land in
most jumbo loan neighborhoods limit supply relative to demand.
COMMERCIAL REAL ESTATE LOANS
While our primary investment focus is on high-quality residential real
estate loans, we also invest in commercial real estate loans. Starting in 1998,
we originated commercial real estate loans for our portfolio. Currently, our
goal is to increase the size of our commercial real estate loan portfolio
through acquisition rather
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than origination. We finance our commercial real estate loan portfolio with
equity and through selling senior loan participations. We intend to acquire
commercial real estate loans, loan participations, mezzanine loans, commercial
real estate loan securities, and commercial credit-enhancement securities in the
future. In addition, we may acquire interests in joint ventures of other
entities that invest in these types of commercial loans and securities.
To date, we have had few delinquencies and losses on our investments in
commercial real estate loans. A slowing economy, and factors particular to each
commercial loan, could cause credit losses in the future. As this occurs, we
would provide for future losses by creating a specific credit reserve on a
loan-by-loan basis.
SECURITIES PORTFOLIO
Our securities portfolio contains all the securities we own that are not
considered residential credit-enhancement securities or cash-equivalents.
With regard to investing in real estate loan securities and in structuring
asset-backed securities issuance to fund investments in these securities, we
believe we have certain advantages relative to other capital markets investors.
We believe we are an efficient company with capable and experienced professional
staff. We are not burdened by over-regulation and we benefit from certain
REIT-related tax advantages.
Most of the securities included in our CDO securitizations, and reported
on our balance sheet as assets, are rated investment-grade (AAA to BBB) or rated
BB. As a result, we generally do not take primary credit risk with respect to
the loans underlying these securities because we benefit from credit enhancement
provided by others. We own real estate securities backed by prime residential
loans, sub-prime residential loans, manufactured housing loans, and commercial
real estate loans. We also own CDO debt and equity, collateralized debt
obligations, that are re-securitizations of diverse real estate securities and
we own corporate bonds issued by REITs that own commercial real estate
properties.
We fund our securities and some of our credit-enhancement securities with
equity and with asset-backed securities, accounted for as long-term debt, issued
through our Acacia private CDO securitization program. We currently use
short-term recourse debt financing for our securities portfolio only on a
temporary basis while we are accumulating securities prior to a CDO issuance.
We invest in diverse real estate loan securities for several reasons:
- Acquiring these various types of real estate securities to support
our CDO program allows us to resecuritize our BB-rated residential
credit-enhancement securities. Accumulation of a diverse pool of
securities, of which our residential credit-enhancement securities
are a part, allows us to issue asset-backed securities in the form
of CDO transactions.
- Given our balance sheet characteristics, tax status, and the
capabilities of our staff, we believe our investment in real estate
securities can earn an attractive return on equity.
- Investing in a variety of types of real estate securities
diversifies both our risks and our opportunities.
- By developing our Acacia private CDO issuance program, involving the
accumulation and re-securitization of primarily investment-grade and
BB-rated real estate securities, we can efficiently invest in some
of the investment-grade and BB-rated interests of the
securitizations that we credit enhance and we can efficiently retain
some of the investment-grade and BB-rated bonds that we would
otherwise issue in our securitization of our high-quality
residential real estate loans. It is efficient from an operating
cost perspective for us to increase the size of our investment in
transactions where we are already devoting considerable resources to
underwrite and assess loans and origination and servicing standards.
OUR OPERATIONS
Our portfolio management staff leads flexible interdisciplinary product
management teams that work to acquire attractive real estate loan investments,
issue mortgage-backed and asset-backed securities, and increase our
profitability over time. Our finance staff participates on these teams, and
manages our overall balance sheet, borrowings, cash position, accounting,
finance, tax, equity issuance, and investor relations.
We build and maintain relationships with mortgage originators, such as:
banks that are likely to sell real estate loan portfolios; Wall Street
investment firms that broker real estate securities; mortgage servicing
S-26
companies that process payments for us and assist with loss mitigation;
technology and information providers that help us conduct our business more
effectively; banks and Wall Street investment firms that provide us credit and
assist with the issuance of our long-term debt; commercial property owners and
other participants in the commercial real estate loan market; and the capital
markets investors that buy our issuance of mortgage-backed and asset-backed
securities.
We evaluate, underwrite, and execute real estate asset acquisitions. Some
of the factors that we take into consideration are: asset yield characteristics;
liquidity; anticipated credit losses; expected prepayment rates; the cost and
type of funding available for the particular asset; the amount of capital
necessary to carry the particular investment in a prudent manner and to meet our
internal risk-adjusted capital guidelines; the cost of any hedging that might be
employed; potential market value fluctuations; contribution to our overall
asset/liability objectives; potential earnings volatility in adverse scenarios;
and cash flow characteristics.
We monitor and actively manage our credit risks. We work closely with our
residential and commercial mortgage servicers, especially with respect to
delinquent loans. While procedures for working out troubled credit situations
for residential loans are relatively standardized, we still find that an intense
focus on assisting and monitoring our servicers in this process yields good
results. We work to enforce the representations and warranties of our sellers,
requiring that they meet their obligations to repurchase loans if there is a
breach of the contractural covenants and representations established at the time
of our purchase. If the loans that make up one of our investments start to
under-perform our expectations, or if a servicer is not fully cooperative with
our monitoring efforts, we may seek to sell that investment at the earliest
opportunity before its market value is diminished.
Prior to acquiring a credit enhancement security, we typically review
origination processes, servicing standards, and individual loan data. In some
cases, we underwrite individual loan files. Prior to acquiring whole loans for
our residential real estate loan portfolio, we conduct a legal document review
of the loans, review individual loan characteristics, and underwrite loans that
appear to have higher risk characteristics.
We actively monitor and adjust the asset/liability characteristics of our
balance sheet. We follow our internal risk-adjusted capital guidelines, seeking
to make sure that we are sufficiently capitalized to hold our assets to maturity
through periods of market fluctuation. We monitor our cash levels, the liquidity
of our assets, the stability of our borrowings, and our projected cash flows and
market values to make sure that we maintain a strong liquidity position. We
generally seek to match the interest rate characteristics of our assets and
liabilities. If we cannot achieve our matching objectives on-balance sheet, we
use interest rate hedge agreements to adjust our overall asset/liability mix. We
monitor potential earnings fluctuations and cash flow changes from prepayments.
We project credit losses and cash flows from our credit sensitive assets, and
reassess our credit provisions and reserves, based on information from our loss
mitigation efforts, borrower credit trends, and housing price trends. We monitor
the market values of our assets and liabilities by reviewing pricing from
external and internal sources.
In order to accumulate loans and securities for future securitization
transactions and for liquidity management purposes, we utilize short-term
borrowings from a variety of counter-parties. We structure securitizations, and
work with the credit rating agencies to get optimal ratings and efficient
financing structures for the securities we issue.
FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes certain federal income tax
considerations relevant to Redwood Trust and its stockholders. This discussion
is based on existing United States federal income tax law, which is subject to
change, possibly retroactively. This discussion does not address all aspects of
United States federal income taxation that may be relevant to a particular
stockholder in light of its personal investment circumstances or to certain
types of investors subject to special treatment under the federal income tax
laws (including financial institutions, insurance companies, broker-dealers and,
except to the limited extent discussed below, tax-exempt entities and foreign
taxpayers) and it does not discuss any aspects of state, local or foreign tax
law. This discussion assumes that stockholders will hold their common stock as a
"capital asset" (generally, property held for investment) under the Internal
Revenue Code of 1986, as amended, or the Code. Stockholders are advised to
consult their tax advisors as to the specific tax consequences to them of
purchasing, holding, and disposing of the common stock, including the
application and effect of Federal, state, local, and foreign income and other
tax laws.
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In reading the tax disclosure set forth below, it should be noted that
although Redwood Trust is combined with all of its subsidiaries for financial
accounting purposes, for federal income tax purposes, only Redwood Trust and
Sequoia Mortgage Funding Corporation (and their assets and income) constitute
the REIT, and Redwood Trust's remaining domestic subsidiaries constitute a
separate consolidated group subject to regular corporate income taxes. Redwood's
foreign subsidiaries (i.e., Acacia CDO 1, Ltd., Acacia CDO 2, Ltd., Acacia CDO
3, Ltd. and Acacia CDO 4, Ltd.), are not generally subject to U.S. corporate
income taxes (see discussion below under Taxable REIT Subsidiaries).
GENERAL
In the opinion of Chapman and Cutler LLP, special tax counsel to Redwood
Trust, Redwood Trust, exclusive of any taxable affiliates, has been organized
and operated in a manner which qualifies it as a REIT under the Code since the
commencement of its operations on August 19, 1994 through March 31, 2004, the
date of Redwood Trust's latest unaudited financial statements received by
special tax counsel. However, whether Redwood Trust does and continues to so
qualify will depend on actual operating results and compliance with the various
tests for qualification as a REIT relating to its income, assets, distributions,
ownership and certain administrative matters, the results of which are not
reviewed by special tax counsel on an ongoing basis. No assurance can be given
that the actual results of Redwood Trust's operations for any one taxable year
will satisfy those requirements. Moreover, certain aspects of Redwood Trust's
planned method of operations have not been considered by the courts or the
Internal Revenue Service in any published authorities that interpret the
requirements of REIT status. There can be no assurance that the courts or the
Internal Revenue Service will agree with this opinion. In addition,
qualification as a REIT depends on future transactions and events that cannot be
known at this time. Accordingly, special tax counsel will be unable to opine
whether Redwood Trust will in fact qualify as a REIT under the Code in all
events and for all periods.
The opinions of special tax counsel are based upon existing law, including
the Code, existing treasury regulations, revenue rulings, revenue procedures,
proposed regulations and case law, all of which is subject to change both
prospectively or retroactively. Moreover, relevant laws or other legal
authorities may change in a manner that could adversely affect Redwood Trust or
its stockholders.
If Redwood Trust failed to qualify as a REIT in any particular year, it
would be subject to federal income tax as a regular, domestic corporation, and
its stockholders would be subject to tax in the same manner as stockholders of a
regular corporation. In such event, Redwood Trust could be subject to
potentially substantial income tax liability in respect of each tax year that it
fails to qualify as a REIT as well as the four tax years following the year of
the failure and the amount of earnings and cash available for distribution to
its stockholders could be significantly reduced.
The following is a brief summary of certain technical requirements that
Redwood Trust must meet on an ongoing basis in order to qualify, and remain
qualified, as a REIT under the Code.
STOCK OWNERSHIP TESTS
The capital stock of Redwood Trust must be held by at least 100 persons
for at least 335 days of a twelve-month year, or a proportionate part of a short
tax year. In addition, no more than 50% of the value of Redwood Trust's capital
stock may be owned, directly or indirectly, by five or fewer individuals at all
times during the last half of the tax year. Under the Code, most tax-exempt
entities including employee benefit trusts and charitable trusts (but excluding
trusts described in 401(a) and exempt under 501(a)) are generally treated as
individuals for these purposes. Redwood Trust must satisfy these stock ownership
requirements each tax year. Redwood Trust must solicit information from certain
of its stockholders to verify ownership levels and maintain records regarding
those who do not respond. Redwood Trust's Articles of Incorporation impose
certain repurchase obligations and restrictions regarding the transfer of
Redwood Trust's shares in order to aid in meeting the stock ownership
requirements. If Redwood Trust were to fail either of the stock ownership tests,
it would generally be disqualified from REIT status, unless, in the case of the
"five or fewer" requirement, the "good faith" exemption is available.
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ASSET TESTS
Redwood Trust must generally meet the following asset tests ("REIT Asset
Tests") at the close of each quarter of each tax year:
(a) at least 75% of the value of Redwood Trust's total assets must
consist of qualified real estate assets, government securities,
cash, and cash items ("75% Asset Test");
(b) the value of Redwood Trust's assets consisting of securities (other
than those includible under the 75% Asset Test) must not exceed 25%
of the total value of Redwood Trust's assets;
(c) the value of Redwood Trust's assets consisting of securities of one
or more taxable REIT subsidiaries must not exceed 20% of the value
of Redwood Trust's total assets; and
(d) the value of securities held by Redwood Trust, other than those of
a taxable REIT subsidiary or taken into account for purposes of the
75% Asset Test, must not exceed either (i) 5% of the value of
Redwood Trust's total assets in the case of securities of any one
non-government issuer, or (ii) 10% of the outstanding vote or value
of any such issuer's securities.
In applying the above tests, a REIT is generally required to re-value all
of its assets at the end of any quarter in which it acquires a substantial
amount of new securities or other property other than qualified real estate
assets. Redwood Trust intends to monitor closely the purchase, holding, and
disposition of its assets in order to comply with the REIT Asset Tests. Redwood
Trust expects that substantially all of its assets will be qualified real estate
assets and intends to limit or hold through taxable REIT subsidiaries any assets
not qualifying as qualified real estate assets so as to comply with the above
REIT Asset Tests. If it is anticipated that the above limits would be exceeded,
Redwood Trust intends to take appropriate measures to avoid exceeding such
limits, including the disposition of non-qualifying assets within the permitted
time periods for cure.
GROSS INCOME TESTS
Redwood Trust must generally meet the following gross income tests ("REIT
Gross Income Tests") for each tax year:
(a) at least 75% of Redwood Trust's gross income must be derived from
certain specified real estate sources including interest income and
gain from the disposition of qualified real estate assets,
foreclosure property or "qualified temporary investment income"
(i.e., income derived from "new capital" within one year of the
receipt of such capital) ("75% Gross Income Test"); and
(b) at least 95% of Redwood Trust's gross income for each tax year must
be derived from sources of income qualifying for the 75% Gross
Income Test, or from dividends, interest, and gains from the sale
of stock or other securities (including certain interest rate swap
and cap agreements, options, futures and forward contracts entered
into to hedge variable rate debt incurred to acquire qualified real
estate assets) not held for sale in the ordinary course of business
("95% Gross Income Test").
Redwood Trust intends to maintain its REIT status by carefully monitoring
its income, including income from hedging transactions and sales of mortgage
assets, to comply with the REIT Gross Income Tests. In accordance with the Code,
Redwood Trust will treat income generated by its interest rate caps and other
hedging instruments as qualifying income for purposes of the 95% Gross Income
Tests to the extent the interest rate cap or other hedging instrument was
acquired to reduce the interest rate risks with respect to any indebtedness
incurred or to be incurred by Redwood Trust to acquire or carry real estate
assets. In addition, Redwood Trust will treat income generated by other hedging
instruments as qualifying or non-qualifying income for purposes of the 95% Gross
Income Test depending on whether the income constitutes gains from the sale of
securities as defined by the Investment Company Act of 1940. Under certain
circumstances, for example, (i) the sale of a substantial amount of mortgage
assets to repay borrowings in the event that other credit is unavailable or (ii)
an unanticipated decrease in the qualifying income of Redwood Trust which
results in the non-qualifying income exceeding 5% of gross income, Redwood Trust
may be unable to comply with certain of the REIT Gross Income Tests. Inadvertent
failures to comply with the REIT Gross Income Tests will not result in
disqualification of the REIT if certain disclosure and reasonable cause criteria
are met and a 100% tax on the amount equal to the qualified income shortfall is
paid. See "-- Taxation of Redwood Trust" below for a discussion of the tax
consequences of failure to comply with the REIT provisions of the Code.
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DISTRIBUTION REQUIREMENT
Redwood Trust generally is required to distribute to its stockholders an
amount equal to at least 95% of Redwood Trust's REIT taxable income determined
before deduction of dividends paid and by excluding net capital gains. Such
distributions must be made in the tax year to which they relate or, if declared
before the timely filing of Redwood Trust's tax return for such year and paid
not later than the first regular dividend payment after such declaration, in the
following tax year.
The Internal Revenue Service, or IRS, has ruled generally that if a REIT's
dividend reinvestment plan allows stockholders of the REIT to elect to have cash
distributions reinvested in shares of the REIT at a purchase price equal to at
least 95% of the fair market value of such shares on the distribution date, then
such distributions generally qualify towards this distribution requirement.
Redwood Trust maintains a Direct Stock Purchase and Dividend Reinvestment Plan,
or DRP, and intends that the terms of its DRP will comply with the IRS public
ruling guidelines for such plans.
If Redwood Trust fails to meet the distribution test as a result of an
adjustment to Redwood Trust's taxable income by the IRS, Redwood Trust may be
able to avoid disqualification as a REIT by paying a "deficiency" dividend
within a specified time period and in accordance with other requirements set
forth in the Code. Redwood Trust would be liable for interest based on the
amount of the deficiency dividend. A deficiency dividend is not permitted if the
deficiency is due to fraud with intent to evade tax or to a willful failure to
file timely tax return.
QUALIFIED REIT SUBSIDIARIES
A Qualified REIT Subsidiary is any corporation in which a REIT owns 100%
of the stock issued by such corporation and for which no election has been made
to classify it as a taxable REIT subsidiary. Sequoia Mortgage Funding
Corporation, a wholly-owned subsidiary of Redwood Trust, is treated as a
Qualified REIT Subsidiary. As such its assets, liabilities, and income are
generally treated as assets, liabilities, and income of Redwood Trust for
purposes of each of the above REIT qualification tests.
TAXABLE REIT SUBSIDIARIES
A Taxable REIT Subsidiary is any corporation in which a REIT owns stock
(directly or indirectly) and for which the REIT and such corporation make a
joint election to classify the corporation as a Taxable REIT Subsidiary.
Effective January 1, 2001, RWT Holdings, Inc., or Holdings, and Redwood Trust
elected to treat Holdings, Sequoia Residential Funding, and Holdings' other
subsidiaries as Taxable REIT Subsidiaries of Redwood Trust. In 2002, Redwood
Trust made a Taxable REIT Subsidiary election for Acacia CDO 1, Ltd., a newly
formed corporation. In 2003, Redwood Trust made a Taxable REIT Subsidiary
election for Acacia CDO 2, Ltd., Acacia CDO 3, Ltd., and Acacia CDO 4, Ltd.,
each a newly formed corporation. As Taxable REIT Subsidiaries, they are not
subject to the REIT asset, income, and distribution requirements nor are their
assets, liabilities, or income treated as assets, liabilities, or income of
Redwood Trust for purposes of each of the above REIT qualification tests.
Redwood Trust generally intends to engage in securitization transactions
(other than certain non-REMIC, debt-for-tax securitizations) through its Taxable
REIT Subsidiaries. In addition, Redwood Trust generally intends to make a
Taxable REIT Subsidiary election with respect to any other corporation in which
it acquires equity or equity-like securities constituting more than 10% by vote
or value of such corporation and that is not otherwise a Qualified REIT
Subsidiary. However, the aggregate value of all of Redwood Trust's Taxable REIT
Subsidiaries must be limited to 20% of the total value of the REIT's assets. In
addition, Redwood Trust will be subject to a 100% penalty tax on any rent,
interest, or other charges that it imposes on any Taxable REIT Subsidiary in
excess of an arm's length price for comparable services. Redwood Trust expects
that any rents, interest, or other charges imposed on Holdings or any other
Taxable REIT Subsidiary will be at arm's length prices.
Redwood Trust generally expects to derive income from its Taxable REIT
Subsidiaries by way of dividends. Such dividends are not real estate source
income for purposes of the 75% Gross Income Test. Therefore, when aggregated
with Redwood Trust's other non-real estate source income, such income must be
limited to 25% of the REIT's gross income each year. Redwood Trust will monitor
the value of its investment in, and the distributions from, its Taxable REIT
Subsidiaries to ensure compliance with all applicable REIT income and asset
tests.
S-30
Taxable REIT Subsidiaries doing business in the United States are
generally subject to corporate level tax on their net income and generally will
be able to distribute only net after-tax earnings to its stockholders, including
Redwood Trust, as dividend distributions. Acacia CDOs are considered foreign
subsidiaries not engaged in trade or business in the United States for tax
purposes and therefore are not subject to U.S. corporate income taxation
(although income from our equity investments in the Acacia CDOs is generally
includable in REIT taxable income or the taxable income of our other Taxable
REIT Subsidiaries that are its stockholders). There is no guarantee that the IRS
will not take the position that Acacia CDOs are doing business in the U.S.,
which position, if sustained, would subject them to corporate level tax on their
effectively connected U.S. trade or business income. If this were to occur, then
the Acacia CDOs would generally only be able to contribute net after-tax
earnings to REIT dividend distributions.
TAXATION OF REDWOOD TRUST
In any year in which Redwood Trust qualifies as a REIT, Redwood Trust will
generally not be subject to federal income tax on that portion of its REIT
taxable income or capital gain that is distributed to its stockholders. Redwood
Trust will, however, be subject to federal income tax at normal corporate income
tax rates upon any undistributed taxable income or capital gain.
In addition, notwithstanding its qualification as a REIT, Redwood Trust
may also be subject to tax in certain other circumstances. As described above,
if Redwood Trust fails to satisfy the REIT Gross Income Tests, but nonetheless
maintains its qualification as a REIT because certain other requirements are
met, it will generally be subject to a 100% tax on the greater of the amount by
which Redwood Trust fails either the 75% or the 95% Gross Income Test. Redwood
Trust will also be subject to a tax of 100% on net income derived from any
"prohibited transaction," which refers to dispositions of property classified as
"property held for sale to customers in the ordinary course of business" (i.e.,
"dealer" property). Redwood Trust does not believe that it has or will engage in
transactions that would result in it being classified as a dealer or deemed to
have disposed of dealer property; however, there can be no assurance that the
IRS will agree. If Redwood Trust has (i) net income from the sale or other
disposition of "foreclosure property" which is held primarily for sale to
customers in the ordinary course of business or (ii) other non-qualifying income
from foreclosure property, it will be subject to federal income tax on such
income at the highest corporate income tax rate. In addition, a nondeductible
excise tax, equal to 4% of the excess of required distributions over the amounts
actually distributed will be imposed on Redwood Trust for each calendar year to
the extent that dividends paid during the year, or declared during the last
quarter of the year and paid during January of the succeeding year, are less
than the sum of (1) 85% of Redwood Trust's "ordinary income," (2) 95% of Redwood
Trust's capital gain net income, plus (3) any undistributed income remaining
from earlier years. Redwood Trust may also be subject to the corporate
alternative minimum tax, as well as other taxes in certain situations not
presently contemplated.
If Redwood Trust fails any of the above described REIT qualification tests
in any tax year and the relief provisions provided by the Code do not apply,
Redwood Trust would be subject to federal income tax (including any applicable
alternative minimum tax) on its taxable income at the regular corporate income
tax rates. Distributions to stockholders in any year in which Redwood Trust
fails to qualify as a REIT would not be deductible by Redwood Trust, nor would
distributions generally be required to be made under the Code. Further, unless
entitled to relief under certain other provisions of the Code, Redwood Trust
would also be disqualified from re-electing REIT status for the four tax years
following the year in which it became disqualified.
Redwood Trust may also voluntarily revoke its election to be taxed as a
REIT, although it has no intention of doing so, in which event Redwood Trust
will be prohibited, without exception, from electing REIT status for the year to
which the revocation relates and the following four tax years.
Redwood Trust intends to monitor on an ongoing basis its compliance with
the REIT requirements described above. In order to maintain its REIT status,
Redwood Trust may be required to limit the types of assets that it might
otherwise acquire, or hold certain assets at times when it might otherwise have
determined that the sale or other disposition of such assets would have been
more prudent.
TAXATION OF STOCKHOLDERS
For any tax year in which Redwood Trust is treated as a REIT for federal
income tax purposes, distributions (including constructive or in-kind
distributions) made to holders of common stock other than tax-exempt entities
(and not designated as capital gain dividends) will generally be subject to tax
as ordinary income to the extent of Redwood Trust's current and accumulated
earnings and profits as determined for federal income
S-31
tax purposes. If the amount distributed exceeds a stockholder's allocable share
of such earnings and profits, the excess will be treated as a return of capital
to the extent of the stockholder's adjusted basis in the common stock, which
will not be subject to tax, and thereafter as a taxable gain from the sale or
exchange of a capital asset.
Distributions designated by Redwood Trust as capital gain dividends will
generally be subject to tax as long-term capital gain to stockholders, to the
extent that the distribution does not exceed Redwood Trust's actual net capital
gain for the tax year. Alternatively, Redwood Trust can also elect by written
notice to its stockholders to designate a portion of its net capital gain income
as being retained and pay directly the tax on such net capital gains. In that
instance, each stockholder generally be required to include the deemed capital
gains dividend in its income, will be entitled to claim a credit or refund on
its tax return for the tax paid by Redwood Trust with respect to such deemed
dividend, and will be entitled to increase its tax basis in Redwood Trust shares
by an amount equal to the excess of the deemed capital gain dividend over the
tax deemed paid by it.
Distributions by Redwood, whether characterized as ordinary income or as
capital gain, are not eligible for the corporate dividends received deduction
that exists under current law. Furthermore, distributions by Redwood
characterized as ordinary income will generally are not subject to the reduced
15% and 5% tax rates otherwise effective for certain types of dividends as of
January 1, 2003. However, dividend distributions by Redwood characterized as
capital gain distributions recognized subsequent to May 5, 2003, will be subject
to the reduced 5% and 15% tax rates made effective by the Jobs and Growth Relief
Reconciliation Tax Act of 2003.
In the event that Redwood Trust realizes a loss for the tax year,
stockholders will not be permitted to deduct any share of that loss. Further, if
Redwood Trust (or a portion of its assets) were to be treated as a taxable
mortgage pool, or if it were to hold residual interests in real estate mortgage
investment conduits, or REMICs, or financial asset securitization investment
trusts, or FASITs, any "excess inclusion" income derived therefrom and allocated
to a stockholder would not be allowed to be offset by a net operating loss of
such stockholder.
Dividends declared during the last quarter of a tax year and actually paid
during January of the following tax year are generally treated as if received by
the stockholder on December 31 of the tax year in which they are declared and
not on the date actually received. In addition, Redwood Trust may elect to treat
certain other dividends distributed after the close of the tax year as having
been paid during such tax year, but stockholders will be treated as having
received such dividend in the tax year in which the distribution is made.
Generally, a dividend distribution of earnings from a REIT is considered
for estimated tax purposes only when the dividend is made. However, any person
owning at least 10% of the vote or value of a closely-held REIT must accelerate
recognition of year-end dividends received from the REIT in computing estimated
tax payments. Redwood Trust is not currently, and does not intend to be, a
closely-held REIT.
Upon a sale or other disposition of the common stock, a stockholder will
generally recognize a capital gain or loss in an amount equal to the difference
between the amount realized and the stockholder's adjusted basis in such stock,
which gain or loss generally will be long-term if the stock was held for more
than twelve months. Any loss on the sale or exchange of common stock held by a
stockholder for six months or less will generally be treated as a long-term
capital loss to the extent of designated capital gain dividends received by such
stockholder. If stock is sold after a record date but before a payment date for
declared dividends on such stock, a stockholder will nonetheless be required to
include such dividend in income in accordance with the rules above for
distributions, whether or not such dividend is required to be paid over to the
purchaser.
DRP participants will generally be treated as having received a dividend
distribution, subject to tax as ordinary income, in an amount equal to the fair
market value of the common stock purchased with the reinvested dividend proceeds
generally on the date Redwood Trust credits such common stock to the DRP
participant's account, plus brokerage commissions, if any, allocable to the
purchase of such common stock. DRP participants will have a tax basis in the
shares equal to such value. DRP participants may not, however, receive any cash
with which to pay the resulting tax liability. Shares received pursuant to the
DRP will have a holding period beginning on the day after their purchase by the
plan administrator.
If Redwood Trust makes a distribution of stockholder rights with respect
to its common stock, such distribution generally will not be treated as taxable
when made. However, if the fair market value of the rights on the date of
issuance is 15% or more of the value of the common stock, or if the stockholder
so elects regardless of the value of the rights, the stockholder must make an
allocation of its existing tax basis between
S-32
the rights and the common stock based on their relative value on the date of the
issuance of the rights. On the exercise of the rights, the stockholder will
generally not recognize gain or loss. The stockholder's basis in the shares
received from the exercise of the rights will be the amount paid for the shares
plus the basis, if any, of the rights exercised. Distribution of stockholder
rights with respect to other classes of securities holders generally would be
taxable based on the value of the rights on the date of distribution.
Redwood Trust is required under Treasury Department regulations to demand
annual written statements from the record holders of designated percentages of
its stock disclosing the actual and constructive ownership of such stock and to
maintain permanent records showing the information it has received as to the
actual and constructive ownership of such stock and a list of those persons
failing or refusing to comply with such demand.
In any year in which Redwood Trust does not qualify as a REIT,
distributions made to its stockholders would be taxable in the same manner
discussed above, except that no distributions could be designated as capital
gain dividends, distributions would be eligible for the corporate dividends
received deduction and may be eligible for the reduced tax rates on dividends
(if paid out of previously-taxed earnings), the excess inclusion income rules
would not apply, and stockholders would not receive any share of Redwood Trust's
tax preference items. In such event, however, Redwood Trust would be subject to
potentially substantial federal income tax liability, and the amount of earnings
and cash available for distribution to its stockholders could be significantly
reduced or eliminated.
TAXATION OF TAX-EXEMPT ENTITIES
Subject to the discussion below regarding a "pension-held REIT," a
tax-exempt stockholder is generally not subject to tax on distributions from
Redwood Trust or gain realized on the sale of the common stock or preferred
stock, provided that such stockholder has not incurred indebtedness to purchase
or hold Redwood Trust's common stock or preferred stock, that its shares are not
otherwise used in an unrelated trade or business of such stockholder, and that
Redwood Trust, consistent with its stated intent, does not form taxable mortgage
pools or hold residual interests in REMICs or FASITs that give rise to "excess
inclusion" income as defined under the Code. However, if Redwood Trust was to
hold a residual interest in a REMIC or FASIT, or if a pool of its assets were to
be treated as a "taxable mortgage pool," a portion of the dividends paid to a
tax-exempt stockholder may be subject to tax as unrelated business taxable
income or UBTI. Although Redwood Trust does not intend to acquire such residual
interests or believe that it, or any portion of its assets, will be treated as a
taxable mortgage pool, no assurance can be given that the IRS might not
successfully maintain that such a taxable mortgage pool exists.
If a qualified pension trust (i.e., any pension or other retirement trust
that qualifies under Section 401(a) of the Code) holds more than 10% by value of
the interests in a "pension-held REIT" at any time during a tax year, a
substantial portion of the dividends paid to the qualified pension trust by such
REIT may constitute UBTI. For these purposes, a "pension-held REIT" is a REIT
(i) that would not have qualified as a REIT but for the provisions of the Code
which look through qualified pension trust stockholders in determining ownership
of stock of the REIT and (ii) in which at least one qualified pension trust
holds more than 25% by value of the interest of such REIT or one or more
qualified pension trusts (each owning more than a 10% interest by value in the
REIT) hold in the aggregate more than 50% by value of the interests in such
REIT. Assuming compliance with the ownership limit provisions in Redwood Trust's
Articles of Incorporation it is unlikely that pension plans will accumulate
sufficient stock to cause Redwood Trust to be treated as a pension-held REIT.
Distributions to certain types of tax-exempt stockholders exempt from
federal income taxation under Sections 501 (c)(7), (c)(9), (c)(17), and (c)(20)
of the Code may also constitute UBTI, and such prospective investors should
consult their tax advisors concerning the applicable "set aside" and reserve
requirements.
STATE AND LOCAL TAXES
Redwood Trust and its stockholders may be subject to state or local
taxation in various jurisdictions, including those in which it or they transact
business or reside. The state and local tax treatment of Redwood Trust and its
stockholders may not conform to the federal income tax consequences discussed
above. Consequently, prospective stockholders should consult their own tax
advisors regarding the effect of state and local tax laws on an investment in
the common stock.
S-33
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS
The following discussion summarizes certain United States Federal tax
consequences of the acquisition, ownership and disposition of common stock or
preferred stock by an initial purchaser that, for United States federal income
tax purposes, is a "Non-United States Holder." Non-United States Holder is any
beneficial holder that is: not a citizen or resident of the United States; not a
corporation, partnership, or other entity created or organized in the United
States or under the laws of the United States or of any political subdivision
thereof; and not an estate or trust whose income is includible in gross income
for United States federal income tax purposes regardless of its source. This
discussion does not consider any specific facts or circumstances that may apply
to particular Non-United States Holder's acquiring, holding, and disposing of
common stock or preferred stock, or any tax consequences that may arise under
the laws of any foreign, state, local, or other taxing jurisdiction.
DIVIDENDS
Dividends paid by Redwood Trust out of earnings and profits, as determined
for United States federal income tax purposes, to a Non-United States Holder
will generally be subject to withholding of United States federal income tax at
the rate of 30%, unless reduced or eliminated by an applicable tax treaty or
unless such dividends are treated as effectively connected with a United States
trade or business. Distributions paid by Redwood Trust in excess of its earnings
and profits will be treated as a tax-free return of capital to the extent of the
holder's adjusted basis in his shares, and thereafter as gain from the sale or
exchange of a capital asset as described below. If it cannot be determined at
the time a distribution is made whether such distribution will exceed the
earnings and profits of Redwood Trust, the distribution will be subject to
withholding at the same rate as dividends. Amounts so withheld, however, will be
refundable or creditable against the Non-United States Holder's United States
Federal tax liability if it is subsequently determined that such distribution
was, in fact, in excess of the earnings and profits of Redwood Trust. If the
receipt of the dividend is treated as being effectively connected with the
conduct of a trade or business within the United States by a Non-United States
Holder, the dividend received by such holder will be subject to the United
States federal income tax on net income that applies to United States persons
generally (and, with respect to corporate holders and under certain
circumstances, the branch profits tax).
For any year in which Redwood Trust qualifies as a REIT, distributions to
a Non-United States Holder that are attributable to gain from the sales or
exchanges by Redwood Trust of "United States real property interests" will be
treated as if such gain were effectively connected with a United States business
and will thus be subject to tax at the normal capital gain rates applicable to
United States stockholders (subject to applicable alternative minimum tax) under
the provisions of the Foreign Investment in Real Property Tax Act of 1980, or
FIRPTA. Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled to a
treaty exemption. Redwood Trust is required to withhold 35% of any distribution
that could be designated by Redwood Trust as a capital gains dividend. This
amount may be credited against the Non-United States Holder's FIRPTA tax
liability. It should be noted that mortgage loans without substantial equity or
with shared appreciation features generally would not be classified as "United
States real property interests."
GAIN ON DISPOSITION
A Non-United States Holder will generally not be subject to United States
federal income tax on gain recognized on a sale or other disposition of its
shares of either common or preferred stock unless (i) the gain is effectively
connected with the conduct of a trade or business within the United States by
the Non-United States Holder, (ii) in the case of a Non-United States Holder who
is a nonresident alien individual and holds such shares as a capital asset, such
holder is present in the United States for 183 or more days in the tax year and
certain other requirements are met, or (iii) the Non-United States Holder is
subject to tax under the FIRPTA rules discussed below. Gain that is effectively
connected with the conduct of a business in the United States by a Non-United
States Holder will be subject to the United States federal income tax on net
income that applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits tax) but
will not be subject to withholding. Non-United States Holders should consult
applicable treaties, which may provide for different rules.
Gain recognized by a Non-United States Holder upon a sale of either common
stock or preferred stock will generally not be subject to tax under FIRPTA if
Redwood Trust is a "domestically-controlled REIT,"
S-34
which is defined generally as a REIT in which at all times during a specified
testing period less than 50% in value of its shares were held directly or
indirectly by non-United States persons. Because only a minority of Redwood
Trust's stockholders are believed to be Non-United States Holders, Redwood Trust
anticipates that it will qualify as a "domestically-controlled REIT."
Accordingly, a Non-United States Holder should not be subject to United States
federal income tax from gains recognized upon disposition of its shares.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Redwood Trust will report to its U.S. stockholders and the Internal
Revenue Service the amount of distributions paid during each calendar year, and
the amount of tax withheld, if any. Under the backup withholding rules, a
stockholder may be subject to backup withholding with respect to distributions
paid (at the rate generally equal to the fourth lowest rate of federal income
tax then in effect) unless such holder (a) is a corporation or comes within
certain other exempt categories and, when required, demonstrates that fact; or
(b) provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with applicable
requirements of the backup withholding rules. A stockholder that does not
provide Redwood Trust with its correct taxpayer identification number may also
be subject to penalties imposed by the IRS. Any amount paid as backup
withholding will be creditable against the stockholder's income tax liability.
In addition, Redwood Trust may be required to withhold a portion of dividends
and capital gain distributions to any stockholders that do not certify under
penalties of perjury their non-foreign status to Redwood Trust.
UNDERWRITING
The underwriter, JMP Securities LLC, has agreed with us, subject to the
terms and conditions of the underwriting agreement, to purchase from us
1,050,000 shares of our common stock.
The underwriting agreement provides that the obligations of the
underwriter are subject to certain conditions precedent and that the underwriter
will purchase all shares of the common stock if any of these shares are
purchased. The underwriter is obligated to take and pay for all of the shares of
common stock offered in this offering, other than those covered by the
over-allotment option described below if any are taken.
The underwriter has advised us that it proposes to offer the shares of
common stock to the public at the offering price set forth on the cover page of
this prospectus supplement and to certain dealers at that price less a
concession not in excess of $1.05 per share. The underwriter may allow, and the
dealers may re-allow, a concession not in excess of $0.10 per share to some
other dealers. After the offering, the offering price and other selling terms
may be changed by the underwriter.
Pursuant to the underwriting agreement, we have granted to the underwriter
an option, exercisable for 30 days after the initial closing, to purchase up to
150,000 additional shares of common stock at the offering price, less the
underwriting discounts and commissions set forth on the cover page of this
prospectus supplement, solely to cover over-allotments.
To the extent that the underwriter exercises its option, the underwriter
will become obligated, subject to some conditions, to purchase all 150,000
shares subject to the option, and we will be obligated, pursuant to the option,
to sell these shares to the underwriters.
We and each of our directors and executive officers have agreed, subject
to specified exceptions, including optional cash payments under our direct stock
purchase and dividend reinvestment plan, not to offer to sell, contract to sell,
or otherwise sell, dispose of, loan, pledge or grant any rights with respect to
any shares of common stock or any options or warrants to purchase any shares of
common stock, or any securities convertible into or exchangeable for shares of
common stock owned as of the date of this prospectus supplement or thereafter
acquired directly by those holders or with respect to which they have the power
of disposition, without the prior written consent of JMP Securities LLC. This
restriction terminates at the close of trading on the 60th day, after (and
including) the day the common stock issued in this offering commences trading on
the New York Stock Exchange. However, JMP Securities LLC may, in its sole
discretion and at any time or from time to time before the termination of the
60-day period, without notice, release all or any portion of the securities
subject to lock-up agreements. There are no existing agreements between JMP
Securities LLC and any of our stockholders who have executed a lock-up agreement
providing consent to the sale of shares prior to the expiration of the lock-up
period.
S-35
In addition, we have agreed that during the lock-up period we will not,
without the prior written consent of JMP Securities LLC, consent to the
disposition of any shares held by stockholders subject to market stand-off
agreements, nor will we consent to the removal of restrictive legends from
shares of our common stock, subject to certain limited exceptions, prior to the
expiration of such lock-up period, or issue, sell, contract to sell, or
otherwise dispose of, any shares of common stock, any options or warrants to
purchase any shares of common stock or any securities convertible into,
exercisable for or exchangeable for shares of common stock other than our sale
of shares in this offering; provided, however, that we may issue and sell our
common stock pursuant to our existing stock option, stock ownership and direct
stock purchase and dividend reinvestment plans that are in effect as of the date
of this prospectus supplement, and that we may issue our common stock upon the
conversion of securities or the exercise of warrants outstanding as of the date
of this prospectus supplement.
The underwriter has advised us that it does not intend to confirm sales to
any account over which it exercises discretionary authority.
The following table summarizes the discounts and commissions to be paid to
the underwriter by us in connection with this offering. These amounts are shown
assuming both no exercise and full exercise of the underwriter's option to
purchase additional shares of common stock.
Paid By Us
-----------------------
No Full
Exercise Exercise
---------- ----------
Per share......................................... $ 1.808 $ 1.808
---------- ----------
Total............................................. $1,898,400 $2,169,600
========== ==========
We expect to incur expenses of approximately $100,000 in connection with
this offering.
We have agreed to indemnify the underwriter against some liabilities,
including liabilities under the Securities Act of 1933.
Until the distribution of the common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriter to
bid for and purchase the common stock. As an exception to these rules, the
underwriter is permitted to engage in certain transactions that stabilize,
maintain or otherwise affect the price of the common stock.
If the underwriter creates a short position in common stock in connection
with the offering, i.e., if it sells a greater aggregate number of shares of
common stock than is set forth on the cover page of this prospectus supplement,
the underwriter may reduce the short position by purchasing shares of our common
stock in the open market. This is known as a "syndicate covering transaction."
The underwriter may also elect to reduce any short position by exercising all or
part of the over-allotment option described above.
Naked short sales are sales in excess of the over-allotment option. The
underwriter must close out any naked short position by purchasing shares of our
common stock in the open market. A naked short position is more likely to be
created if the underwriter is concerned that there may be downward pressure on
the price of the shares in the open market after pricing that could adversely
affect investors who purchase in the offering.
The underwriter may also impose a penalty bid on some selling group
members. This means that if the underwriter purchases common stock in the open
market to reduce the selling group members' short position or to stabilize the
price of the common stock, it may reclaim the amount of the selling concession
from the selling group members who sold those shares of common stock as part of
the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of the purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it were
to discourage resale of the security.
EXPERTS
The financial statements incorporated in this prospectus supplement by
reference to the Annual Report on Form 10-K for the year ended December 31,
2003, have been so incorporated in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
S-36
LEGAL MATTERS
Selected legal matters relating to the common stock will be passed on for
us by Tobin & Tobin, a professional corporation, San Francisco, California.
Legal matters relating to our tax status as a REIT will be passed on for us by
Chapman and Cutler LLP, San Francisco, California. Certain legal matters will be
passed upon for the underwriter by O'Melveny & Myers LLP, San Francisco,
California.
INCORPORATION BY REFERENCE
The SEC allows us to "incorporate by reference" information into this
prospectus supplement, which means that we can disclose important information to
you by referring you to another document filed separately with the SEC. The
information incorporated by reference is deemed to be part of this prospectus
supplement, except for any information superseded by information in this
prospectus supplement.
We have filed the documents listed below with the SEC under the Securities
Exchange Act of 1934, or the Exchange Act, and these documents are incorporated
herein by reference:
- Our Annual Report on Form 10-K for the year ended December 31, 2003;
- Our Definitive Proxy Statement on Schedule 14A filed April 2, 2004;
- Our Quarterly Report on Form 10-Q for the three months ended March
31, 2004; and
- The description of our common stock included in our registration
statement on Form 8-A, filed July 18, 1995 (Registration No.
0-26434) and as amended by Form 8-A/A filed August 4, 1995, under
the Exchange Act.
Any statement contained in a document incorporated by reference shall be
deemed to be modified or superseded for all purposes to the extent that a
statement contained in this prospectus supplement modifies or supersedes that
statement.
You may obtain copies of all documents which are incorporated in this
prospectus supplement by reference (other than the exhibits to such documents
unless the exhibits are specifically incorporated herein by reference in the
documents that this prospectus supplement incorporates by reference) without
charge upon written or oral request to Redwood Trust, Inc., One Belvedere Place,
Suite 300, Mill Valley, CA 94941, telephone (415) 389-7373.
S-37
PROSPECTUS
MAY 13, 2004
COMMON STOCK, PREFERRED STOCK, WARRANTS,
AND STOCKHOLDER RIGHTS TO PURCHASE
COMMON STOCK AND PREFERRED STOCK
$384,075,000
RWT
REDWOOD TRUST, INC.
-------------------
By this prospectus, we may offer, from time to time, securities consisting
of:
- shares of our common stock
- shares of our preferred stock
- any warrants to purchase our common stock or preferred stock
- rights to purchase our common stock or preferred stock issued to our
stockholders
- any combination of the foregoing
We will provide specific terms of these securities in supplements to this
prospectus. You should read this prospectus and any supplement carefully before
you decide to invest.
This prospectus may not be used to consummate sales of these securities
unless it is accompanied by a prospectus supplement.
The New York Stock Exchange lists our common stock under the symbol "RWT."
To ensure we qualify as a real estate investment trust, no person may own
more than 9.8% of the outstanding shares of any class of our common stock or our
preferred stock, unless our Board of Directors waives this limitation.
-------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS MAY 13, 2004
TABLE OF CONTENTS
PAGE
----
About this Prospectus.................................... 2
Private Securities Litigation Reform Act of 1995......... 2
The Company.............................................. 3
Use of Proceeds.......................................... 3
Description of Securities................................ 3
Federal Income Tax Considerations........................ 8
Plan of Distribution..................................... 15
ERISA Investors.......................................... 17
Legal Matters............................................ 17
Experts.................................................. 17
Where You Can Find More Information...................... 17
Incorporation by Reference............................... 17
ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we filed with the
Securities and Exchange Commission using a "shelf" registration process. Under
this process, we may offer and sell any combination of the securities covered by
this prospectus in one or more offerings up to a total dollar amount of
$384,075,000. This prospectus provides you with a general description of the
securities we may offer. Each time we offer to sell securities, we will provide
a supplement to this prospectus that will contain specific information about the
terms of that offering. The prospectus supplement may also add, update or change
information contained in this prospectus. You should read both this prospectus
and any prospectus supplement together with the additional information you may
need to make your investment decision.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This prospectus and the documents incorporated by reference herein contain
forward-looking statements, as defined in the Private Securities Litigation
Reform Act of 1995, that are based on our current expectations, estimates and
projections. Statements that are not historical facts, including statements
about our beliefs and expectations, are forward-looking statements. These
statements are not guarantees of future performance, events or results and
involve potential risks and uncertainties. Accordingly, our actual results may
differ from our current expectations, estimates and projections. We undertake no
obligation to update publicly any forward-looking statements, whether as a
result of new information, future events or otherwise.
Important factors that may impact our actual results include changes in
interest rates, changes in the yield curve, changes in prepayment rates, the
supply of mortgage loans and mortgage securities, our ability to obtain
financing, the terms of any financing and other factors described in this
prospectus.
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THE COMPANY
Redwood Trust, Inc. is a real estate finance company specializing in
owning, financing and credit-enhancing high-quality jumbo residential mortgage
loans nationwide. We also finance U.S. real estate in a number of other ways,
including through our investment portfolio (investment-grade mortgage
securities) and our commercial loan portfolio. Our primary source of revenues is
monthly payments made by homeowners on their mortgages. Our primary expense is
the cost of borrowed funds. Since we are structured as a Real Estate Investment
Trust (REIT), we distribute the bulk of our net earnings to stockholders as
dividends. Our REIT status permits us to deduct dividend distributions to
stockholders from our taxable income, thereby eliminating the "double taxation"
that generally results when a corporation earns income and distributes that
income to stockholders in the form of dividends. We are self-advised and
self-managed. Our principal executive offices are located at One Belvedere
Place, Suite 300, Mill Valley, CA 94941, telephone 415-389-7373.
USE OF PROCEEDS
Unless otherwise specified in the applicable prospectus supplement, we
intend to use the net proceeds from the securities for acquisition of mortgage
assets and general corporate purposes. Pending any such uses, we may invest the
net proceeds from the sale of any securities or may use them to reduce
short-term or adjustable-rate indebtedness. If we intend to use the net proceeds
from a sale of securities to finance a significant acquisition of a business, a
related prospectus supplement will describe the material terms of such
acquisition.
DESCRIPTION OF SECURITIES
GENERAL
The following is a brief description of the material terms of our
securities that may be offered under this prospectus. This description does not
purport to be complete and is subject in all respects to applicable Maryland law
and to the provisions of our Charter and Bylaws, including any applicable
amendments or supplements thereto, copies of which are on file with the
Commission as described under "Available Information" and are incorporated by
reference herein.
We may offer under this prospectus one or more of the following types of
securities: shares of common stock, par value $0.01 per share; shares of
preferred stock, in one or more classes or series; common stock warrants;
preferred stock warrants; stockholder rights; and any combination of the
foregoing, either individually or as units consisting of one or more of the
foregoing types of securities. The terms of any specific offering of securities,
including the terms of any units offered, will be set forth in a prospectus
supplement relating to such offering.
Our current authorized equity capitalization consists of 50 million shares
which may be comprised of common stock and preferred stock. The common stock is
listed on the New York Stock Exchange, and we intend to so list any additional
shares of our common stock which are issued and sold hereunder. We may elect to
list any future class or series of our securities issued hereunder on an
exchange, but we are not obligated to do so.
COMMON STOCK
Common stockholders are entitled to receive dividends when, as and if
declared by our board of directors, out of legally available funds. In the event
any future class or series of preferred stock is issued, dividends on any
outstanding shares of preferred stock may be required to be paid in full before
payment of any dividends on the common stock. If we have a liquidation,
dissolution or winding up, common stockholders are entitled to share ratably in
all of our assets available for distribution after payment of all our debts and
other liabilities and the payment of all liquidation and other preference
amounts to preferred stockholders then outstanding. There are no preemptive or
other subscription rights, conversion rights, or redemption or sinking fund
provisions with respect to shares of common stock.
Each holder of common stock is entitled to one vote per share with respect
to all matters submitted to a vote of stockholders and do not have cumulative
voting rights. Accordingly, holders of a majority of the common stock entitled
to vote in any election of directors may elect all of the directors standing for
election, subject to the voting rights, if any, of any class or series of
preferred stock that may be outstanding from time to time. Our charter and
bylaws contain no restrictions on our repurchase of shares of the common stock.
All the
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outstanding shares of common stock are, and additional shares of common stock
will be, validly issued, fully paid and nonassessable.
PREFERRED STOCK
Our board of directors is authorized to designate with respect to each
class or series of preferred stock the number of shares in each such class or
series, the dividend rates and dates of payment, voluntary and involuntary
liquidation preferences, redemption prices, if any, whether or not dividends
shall be cumulative, and, if cumulative, the date or dates from which the same
shall be cumulative, the sinking fund provisions if any, the terms and
conditions on which shares can be converted into or exchanged for shares of
another class or series, including any anti-dilution provisions, and the voting
rights, if any.
Any preferred stock issued may rank prior to the common stock as to
dividends and will rank prior to the common stock as to distributions in the
event of our liquidation, dissolution or winding up. The ability of our board of
directors to issue preferred stock, while providing flexibility in connection
with possible acquisitions and other corporate purposes, could, among other
things, adversely affect the voting powers of common stockholders. The shares of
any future class or series of preferred stock will be, validly issued, fully
paid and nonassessable.
SECURITIES WARRANTS
We may issue securities warrants for the purchase of common stock or
preferred stock, respectively referred to as common stock warrants and preferred
stock warrants. Securities warrants may be issued independently or together with
any other securities offered by this prospectus and any accompanying prospectus
supplement and may be attached to or separate from such other securities. Each
issuance of the securities warrants will be issued under a separate securities
warrant agreement to be entered into by us and a bank or trust company, as
securities warrant agent, all as set forth in the prospectus supplement relating
to the particular issue of offered securities warrants. Each issue of securities
warrants will be evidenced by securities warrant certificates. The securities
warrant agent will act solely as an agent of ours in connection with the
securities warrants certificates and will not assume any obligation or
relationship of agency or trust for or with any holder of securities warrant
certificates or beneficial owners of securities warrants.
If we offer securities warrants pursuant to this prospectus in the future,
the applicable prospectus supplement will describe the terms of such securities
warrants, including the following, where applicable:
- the offering price;
- the aggregate number of shares purchasable upon exercise of such
securities warrants, and in the case of securities warrants for
preferred stock, the designation, aggregate number and terms of the
class or series of preferred stock purchasable upon exercise of such
securities warrants;
- the designation and terms of the securities with which such
securities warrants are being offered, if any, and the number of
such securities warrants being offered with each such security;
- the date on and after which such securities warrants and any related
securities will be transferable separately;
- the number of shares of preferred stock or shares of common stock
purchasable upon exercise of each of such securities warrant and the
price at which such number of shares of preferred stock or common
stock may be purchased upon such exercise;
- the date on which the right to exercise such securities warrants
shall commence and the expiration date on which such right shall
expire;
- federal income tax considerations; and
- any other material terms of such securities warrants.
Holders of future securities warrants, if any, will not be entitled by
virtue of being such holders, to vote, to consent, to receive dividends, to
receive notice with respect to any meeting of stockholders for the election of
our directors or any other matter, or to exercise any rights whatsoever as
stockholders of Redwood Trust.
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STOCKHOLDER RIGHTS
We may issue, as a dividend at no cost, stockholder rights to holders of
record of our securities or any class or series thereof on the applicable record
date. If stockholders rights are so issued to existing holders of securities,
each stockholder right will entitle the registered holder thereof to purchase
the securities pursuant to the terms set forth in the applicable prospectus
supplement.
If stockholder rights are issued, the applicable prospectus supplement
will describe the terms of such stockholder rights including the following where
applicable:
- record date;
- subscription price;
- subscription agent;
- aggregate number of shares of preferred stock or shares of common
stock purchasable upon exercise of such stockholder rights and in
the case of stockholder rights for preferred stock, the designation,
aggregate number and terms of the class or series of preferred stock
purchasable upon exercise of such stockholder rights;
- the date on which the right to exercise such stockholder rights
shall commence and the expiration date on which such right shall
expire;
- federal income tax considerations; and
- and other material terms of such stockholder rights.
In addition to the terms of the stockholder rights and the securities
issuable upon exercise thereof, the prospectus supplement may describe, for a
holder of such stockholder rights who validly exercises all stockholder rights
issued to such holder, how to subscribe for unsubscribed securities, issuable
pursuant to unexercised stockholder rights issued to other holders, to the
extent such stockholder rights have not been exercised.
Holders of stockholder rights will not be entitled by virtue of being such
holders, to vote, to consent, to receive dividends, to receive notice with
respect to any meeting of stockholders for the election of our directors or any
other matter, or to exercise any rights whatsoever as stockholders of Redwood
Trust, except to the extent described in the related prospectus supplement.
RESTRICTIONS ON OWNERSHIP AND TRANSFER AND REPURCHASE OF SHARES
In order that we may meet the requirements for qualification as a REIT at
all times, our charter prohibits any person from acquiring or holding beneficial
ownership of a number of shares of common stock or preferred stock
(collectively, the "capital stock") in excess of 9.8% of the outstanding shares
of the related class of capital stock. For this purpose, the term "beneficial
ownership" means beneficial ownership, as determined under Rule 13d-3 under the
Securities Exchange Act of 1934, of capital stock by a person, either directly
or constructively under the constructive ownership provisions of Section 544 of
the Code and related provisions.
Under the constructive ownership rules of Section 544 of the Code, a
holder of a warrant will be treated as owning the number of shares of capital
stock into which such warrant may be converted. In addition, the constructive
ownership rules generally attribute ownership of securities owned by a
corporation, partnership, estate or trust proportionately to its stockholders,
partners or beneficiaries, respectively. The rules may also attribute ownership
of securities owned by family members to other members of the same family and
treat securities with respect to which a person has an option to purchase as
actually owned by that person. The rules further provide when securities
constructively owned by a person are considered to be actually owned for the
application of such attribution provisions. To determine whether a person holds
or would hold capital stock in excess of the 9.8% ownership limit, a person will
be treated as owing not only shares of capital stock actually owned, but also
any shares of capital stock attributed to that person under the attribution
rules described above. Accordingly, a person who individually owns less than
9.8% of the shares outstanding may nevertheless be in violation of the 9.8%
ownership limit.
Any transfer of shares of capital stock warrants that would cause us to be
disqualified as a REIT or that would create a direct or constructive ownership
of shares of capital stock in excess of the 9.8% ownership limit,
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or result in the shares of capital stock being beneficially owned, within the
meaning of Section 856(a) of the Code, by fewer than 100 persons, determined
without any reference to any rules of attribution, or result in us being closely
held within the meaning of Section 856(h) of the Code, will be null and void,
and the intended transferee will acquire no rights to those shares or warrants.
These restrictions on transferability and ownership will not apply if our board
determines that it is no longer in our best interests to continue to qualify as
a REIT.
Any purported transfer of shares of capital stock or warrants that would
result in a purported transferee owning, directly or constructively, shares in
excess of the 9.8% ownership limit due to the unenforceability of the transfer
restrictions described above will constitute excess securities. Excess
securities will be transferred by operation of law to Redwood Trust as trustee
for the exclusive benefit of the person or persons to whom the excess securities
are ultimately transferred, until such time as the purported transferee
retransfers the excess securities. While the excess securities are held in
trust, a holder of such securities will not be entitled to vote or to share in
any dividends or other distributions with respect to such securities and will
not be entitled to exercise or convert such securities into shares of capital
stock. Subject to the 9.8% ownership limit, excess securities may be transferred
by the purported transferee to any person (if such transfer would not result in
excess securities) at a price not to exceed the price paid by the purported
transferee (or, if no consideration was paid by the purported transferee, the
fair market value of the excess securities on the date of the purported
transfer), at which point the excess securities will automatically be exchanged
for the stock or warrants, as the case may be, to which the excess securities
are attributable. If a purported transferee receives a higher price for
designating an ultimate transferee, such purported transferee shall pay, or
cause the ultimate transferee to pay, such excess to us. In addition, such
excess securities held in trust are subject to purchase by us at a purchase
price equal to the lesser of (a) the price per share or per warrant, as the case
may be, in the transaction that created such excess securities (or, in the case
of a devise or gift, the market price at the time of such devise or gift),
reduced by the amount of any distributions received in violation of the charter
that have not been repaid to us, and (b) the market price as reflected in the
last reported sales price of such shares of stock or warrants on the trading day
immediately preceding the date of the purchase by us as reported on any exchange
or quotation system over which such shares of stock or warrants may be traded,
or if not then traded over any exchange or quotation system, then the market
price of such shares of stock or warrants on the date of the purported transfer
as determined in good faith by our board of directors, reduced by the amount of
any distributions received in violation of the charter that have not been repaid
to us.
Upon a purported transfer of excess securities, the purported transferee
shall cease to be entitled to distributions, voting rights and other benefits
with respect to the shares of capital stock or warrants except the right to
payment of the purchase price for the shares of capital stock or warrants on the
retransfer of securities as provided above. Any dividend or distribution paid to
a purported transferee on excess securities prior to our discovery that shares
of capital stock have been transferred in violation of our articles of
incorporation shall be repaid to us upon demand. If these transfer restrictions
are determined to be void, invalid or unenforceable by a court of competent
jurisdiction, then the purported transferee of any excess securities may be
deemed, at our option, to have acted as an agent on our behalf in acquiring the
excess securities and to hold the excess securities on our behalf.
All certificates representing shares of capital stock and warrants will
bear a legend referring to the restrictions described above.
Any person who acquires shares or warrants in violation of our Charter, or
any person who is a purported transferee such that excess securities result,
must immediately give written notice or, in the event of a proposed or attempted
transfer that would be void as set forth above, give at least 15 days prior
written notice to us of such event and shall provide us such other information
as we may request in order to determined the effect, if any, of the transfer on
our status as a REIT. In addition, every record owner of more than 5.0%, during
any period in which the number of record stockholders is 2,000 or more, or 1.0%,
during any period in which the number of record stockholders is greater than 200
but less than 2,000 or more, or 1/2%, during any period in which the number of
record stockholders is 200 or less, of the number or value of our outstanding
shares must send us an annual written notice by January 31 describing how the
shares are held. Further, each stockholder upon demand is required to disclose
to us in writing such information with respect to the direct and constructive
ownership of shares and warrants as our board deems reasonably necessary to
comply with the REIT provisions of the Code, to comply with the requirements of
any taxing authority or governmental agency or to determine any such compliance.
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Our board may increase or decrease the 9.8% ownership limit. In addition,
to the extent consistent with the REIT provisions of the Code, our board may,
pursuant to our Charter, waive the 9.8% ownership limit for a purchaser of our
stock. As a condition to such waiver the intended transferee must give written
notice to the board of the proposed transfer no later than the fifteenth day
prior to any transfer which, if consummated, would result in the intended
transferee owning shares in excess of the ownership limit. Our board may also
take such other action as it deems necessary or advisable to protect our status
as a REIT.
The provisions described above may inhibit market activity and the
resulting opportunity for the holders of our capital stock and warrants to
receive a premium for their shares or warrants that might otherwise exist in the
absence of such provisions. Such provisions also may make us an unsuitable
investment vehicle for any person seeking to obtain ownership of more than 9.8%
of the outstanding shares of our capital stock.
MARYLAND CONTROL SHARE ACQUISITION STATUTE
The Maryland General Corporation Law provides that "control shares" of a
Maryland corporation acquired in a "control share acquisition" have no voting
rights except to the extent approved by a vote of two-thirds of the votes
entitled to be cast on the matter, excluding shares of stock owned by the
acquiror or by officers or directors who are employees of the corporation.
"Control shares" are voting shares of stock which, if aggregated with all other
shares of stock owned by such a person, would entitle the acquiror to exercise
voting power in electing directors within one of the following ranges of voting
power: (i) one-tenth or more but less than one third, (ii) one-third or more but
less than a majority, or (iii) a majority or more of all voting power. "Control
shares" do not include shares of stock the acquiring person is then entitled to
vote as a result of having previously obtained stockholder approval. A "control
share acquisition" means, subject to certain exceptions, the acquisition of,
ownership of, or the power to direct the exercise of voting power with respect
to, control shares.
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions, including an undertaking to pay
expenses, may compel the board of directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an acquiring
person statement as permitted by the statute, then, subject to certain
conditions and limitations, the corporation may redeem any or all of the
"control shares," except those for which voting rights have previously been
approved, for fair value determined, without regard to absence of voting rights,
as of the date of the last control share acquisition or of any meeting of
stockholders at which the voting rights of such shares are considered and not
approved. If voting rights for "control shares" are approved at a stockholders
meeting and the acquiror becomes entitled to vote a majority of the shares
entitled to vote, all other stockholders may exercise appraisal rights. The fair
value of the stock, as determined for purposes of such appraisal rights may not
be less than the highest price per share paid in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of "control share acquisitions."
The "control share acquisition" statute does not apply to stock acquired
in a merger, consolidation or share exchange if the corporation is a party to
the transaction, or to acquisitions approved or exempted by a provision of the
charter or bylaws of the corporation adopted prior to the acquisition of the
shares. The control share acquisition statute could have the effect of
discouraging offers to acquire us and of increasing the difficulty of
consummating any such offers, even if the acquisition would be in our
stockholders' best interests.
CLASSIFICATION OF BOARD OF DIRECTORS, VACANCIES AND REMOVAL OF DIRECTORS
Our Bylaws provide for a staggered Board of Directors divided in to three
classes, with terms of three years each. The number of directors in each class
and the expiration of each class term, as of the date of this prospectus, are as
follows;
Class I..................................................... 3 Directors Expires 2007
Class II.................................................... 3 Directors Expires 2005
Class II.................................................... 2 Directors Expires 2006
At each annual meeting of our stockholders, successors of the class of
directors whose term expires at that meeting will be elected for a three-year
term and the directors in the other two classes will continue in office. A
staggered Board of Directors may delay, defer or prevent a change in our control
or other transaction
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that might involve a premium over the then prevailing market price for our
common stock or other attributes that our stockholders may consider desirable.
In addition, a staggered Board of Directors could prevent stockholders who do
not agree with the policies of our Board of Directors from replacing a majority
of the Board of Directors in two years.
Our Bylaws provide that any vacancy on our Board of Directors may be
filled by a majority vote of the remaining directors. Any individual so elected
director will hold office for the remaining term of the director that he or she
is succeeding. Maryland law provides that if the directors have been divided
into classes, a director may not be removed without cause by the stockholders.
TRANSFER AGENT AND REGISTRAR
Computershare Investor Services LLC is the transfer agent and registrar
with respect to our securities.
FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes the material federal income tax
consequences that may be relevant to a prospective purchaser of securities. It
is not exhaustive of all possible tax considerations. It does not give a
detailed discussion of any state, local or foreign tax considerations, nor does
it discuss all of the aspects of federal income taxation that may be relevant to
a prospective investor in light of such investor's particular circumstances or
to certain types of investors subject to special treatment under federal income
tax laws, including insurance companies, certain tax-exempt entities, financial
institutions, broker/dealers, foreign corporations and persons who are not
citizens or residents of the United States.
EACH PROSPECTIVE PURCHASER OF SECURITIES IS ADVISED TO (i) REVIEW THE
"FEDERAL INCOME TAX CONSIDERATIONS" IN ANY PROSPECTUS SUPPLEMENT DATED AFTER THE
DATE OF THIS PROSPECTUS FOR UPDATES ON MATERIAL CHANGES IN SUCH TAX
CONSIDERATIONS AND (ii) CONSULT WITH HIS OR HER OWN TAX ADVISOR REGARDING THE
SPECIFIC CONSEQUENCES TO HIM OR HER OF THE PURCHASE, OWNERSHIP AND SALE OF
SECURITIES, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX
CONSIDERATIONS OF SUCH PURCHASE, OWNERSHIP AND SALE AND THE POTENTIAL CHANGES IN
APPLICABLE TAX LAWS.
GENERAL
In the opinion of Chapman and Cutler LLP, special tax counsel to Redwood
Trust, Redwood Trust, exclusive of any taxable affiliates, has been organized
and operated in a manner which qualifies it as a REIT under the Code since the
commencement of its operations on August 19, 1994 through December 31, 2003, the
date of Redwood Trust's latest audited financial statements received by special
tax counsel. However, whether Redwood Trust does and continues to so qualify
will depend on actual operating results and compliance with the various tests
for qualification as a REIT relating to its income, assets, distributions,
ownership and certain administrative matters, the results of which are not
reviewed by special tax counsel on an ongoing basis. No assurance can be given
that the actual results of Redwood Trust's operations for any one taxable year
will satisfy those requirements. Moreover, certain aspects of Redwood Trust's
planned method of operations have not been considered by the courts or the
Internal Revenue Service in any published authorities that interpret the
requirements of REIT status. There can be no assurance that the courts or the
Internal Revenue Service will agree with this opinion. In addition,
qualification as a REIT depends on future transactions and events that cannot be
known at this time. Accordingly, special tax counsel will be unable to opine
whether Redwood Trust will in fact qualify as a REIT under the Code in all
events and for all periods.
The opinions of special tax counsel are based upon existing law, including
the Internal Revenue Code of 1986, as amended, existing treasury regulations,
revenue rulings, revenue procedures, proposed regulations and case law, all of
which is subject to change both prospectively or retroactively. Moreover,
relevant laws or other legal authorities may change in a manner that could
adversely affect Redwood Trust or its stockholders.
If Redwood Trust failed to qualify as a REIT in any particular year, it
would be subject to federal income tax as a regular, domestic corporation, and
its stockholders would be subject to tax in the same manner as stockholders of a
regular corporation. In such event, Redwood Trust could be subject to
potentially substantial income tax liability in respect of each tax year that it
fails to qualify as a REIT as well as the four tax years following the year of
the failure and the amount of earnings and cash available for distribution to
its stockholders could be significantly reduced.
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The following is a brief summary of certain technical requirements that
Redwood Trust must meet on an ongoing basis in order to qualify, and remain
qualified, as a REIT under the Code.
STOCK OWNERSHIP TESTS
The capital stock of Redwood Trust must be held by at least 100 persons
for at least 335 days of a twelve-month year, or a proportionate part of a short
tax year. In addition, no more than 50% of the value of Redwood Trust's capital
stock may be owned, directly or indirectly, by five or fewer individuals at all
times during the last half of the tax year. Under the Code, most tax-exempt
entities including employee benefit trusts and charitable trusts (but excluding
trusts described in 401(a) and exempt under 501(a)) are generally treated as
individuals for these purposes. Redwood Trust must satisfy these stock ownership
requirements each tax year. Redwood Trust must solicit information from certain
of its stockholders to verify ownership levels and maintain records regarding
those who do not respond. Redwood Trust's Articles of Incorporation impose
certain repurchase obligations and restrictions regarding the transfer of
Redwood Trust's shares in order to aid in meeting the stock ownership
requirements. If Redwood Trust were to fail either of the stock ownership tests,
it would generally be disqualified from REIT status, unless, in the case of the
"five or fewer" requirement, the "good faith" exemption is available.
ASSET TESTS
Redwood Trust must generally meet the following asset tests ("REIT Asset
Tests") at the close of each quarter of each tax year:
(a) at least 75% of the value of Redwood Trust's total assets must
consist of qualified real estate assets, government securities,
cash, and cash items ("75% Asset Test");
(b) the value of Redwood Trust's assets consisting of securities (other
than those includible under the 75% Asset Test) must not exceed 25%
of the total value of Redwood Trust's assets;
(c) the value of Redwood Trust's assets consisting of securities of one
or more taxable REIT subsidiaries must not exceed 20% of the value
of Redwood Trust's total assets; and
(d) the value of securities held by Redwood Trust, other than those of
a taxable REIT subsidiary or taken into account for purposes of the
75% Asset Test, must not exceed either (i) 5% of the value of
Redwood Trust's total assets in the case of securities of any one
non-government issuer, or (ii) 10% of the outstanding vote or value
of any such issuer's securities.
In applying the above tests, a REIT is generally required to re-value all
of its assets at the end of any quarter in which it acquires a substantial
amount of new securities or other property other than qualified real estate
assets. Redwood Trust intends to monitor closely the purchase, holding, and
disposition of its assets in order to comply with the REIT Asset Tests. Redwood
Trust expects that substantially all of its assets will be qualified real estate
assets and intends to limit or hold through taxable REIT subsidiaries any assets
not qualifying as qualified real estate assets so as to comply with the above
REIT Asset Tests. If it is anticipated that the above limits would be exceeded,
Redwood Trust intends to take appropriate measures to avoid exceeding such
limits, including the disposition of non-qualifying assets within the permitted
time periods for cure.
GROSS INCOME TESTS
Redwood Trust must generally meet the following gross income tests ("REIT
Gross Income Tests") for each tax year:
(a) at least 75% of Redwood Trust's gross income must be derived from
certain specified real estate sources including interest income and
gain from the disposition of qualified real estate assets,
foreclosure property or "qualified temporary investment income"
(i.e., income derived from "new capital" within one year of the
receipt of such capital) ("75% Gross Income Test"); and
(b) at least 95% of Redwood Trust's gross income for each tax year must
be derived from sources of income qualifying for the 75% Gross
Income Test, or from dividends, interest, and gains from the sale
of stock or other securities (including certain interest rate swap
and cap agreements, options, futures and forward contracts entered
into to hedge variable rate debt incurred to acquire qualified real
estate assets) not held for sale in the ordinary course of business
("95% Gross Income Test").
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Redwood Trust intends to maintain its REIT status by carefully monitoring
its income, including income from hedging transactions and sales of mortgage
assets, to comply with the REIT Gross Income Tests. In accordance with the Code,
Redwood Trust will treat income generated by its interest rate caps and other
hedging instruments as qualifying income for purposes of the 95% Gross Income
Tests to the extent the interest rate cap or other hedging instrument was
acquired to reduce the interest rate risks with respect to any indebtedness
incurred or to be incurred by Redwood Trust to acquire or carry real estate
assets. In addition, Redwood Trust will treat income generated by other hedging
instruments as qualifying or non-qualifying income for purposes of the 95% Gross
Income Test depending on whether the income constitutes gains from the sale of
securities as defined by the Investment Company Act of 1940. Under certain
circumstances, for example, (i) the sale of a substantial amount of mortgage
assets to repay borrowings in the event that other credit is unavailable or (ii)
an unanticipated decrease in the qualifying income of Redwood Trust which
results in the non-qualifying income exceeding 5% of gross income, Redwood Trust
may be unable to comply with certain of the REIT Gross Income Tests. Inadvertent
failures to comply with the REIT Gross Income Tests will not result in
disqualification of the REIT if certain disclosure and reasonable cause criteria
are met and a 100% tax on the amount equal to the qualified income shortfall is
paid. See "-- Taxation of Redwood Trust" below for a discussion of the tax
consequences of failure to comply with the REIT provisions of the Code.
DISTRIBUTION REQUIREMENT
Redwood Trust generally is required to distribute to its stockholders an
amount equal to at least 95% of Redwood Trust's REIT taxable income determined
before deduction of dividends paid and by excluding net capital gains. Such
distributions must be made in the tax year to which they relate or, if declared
before the timely filing of Redwood Trust's tax return for such year and paid
not later than the first regular dividend payment after such declaration, in the
following tax year.
The Internal Revenue Service, or IRS, has ruled generally that if a REIT's
dividend reinvestment plan allows stockholders of the REIT to elect to have cash
distributions reinvested in shares of the REIT at a purchase price equal to at
least 95% of the fair market value of such shares on the distribution date, then
such distributions generally qualify towards this distribution requirement.
Redwood Trust maintains a Direct Stock Purchase and Dividend Reinvestment Plan,
or DRP, and intends that the terms of its DRP will comply with the IRS public
ruling guidelines for such plans.
If Redwood Trust fails to meet the distribution test as a result of an
adjustment to Redwood Trust's taxable income by the IRS, Redwood Trust may be
able to avoid disqualification as a REIT by paying a "deficiency" dividend
within a specified time period and in accordance with other requirements set
forth in the Code. Redwood Trust would be liable for interest based on the
amount of the deficiency dividend. A deficiency dividend is not permitted if the
deficiency is due to fraud with intent to evade tax or to a willful failure to
file timely tax return.
QUALIFIED REIT SUBSIDIARIES
A Qualified REIT Subsidiary is any corporation in which a REIT owns 100%
of the stock issued by such corporation and for which no election has been made
to classify it as a taxable REIT subsidiary. Sequoia Mortgage Funding
Corporation, a wholly-owned subsidiary of Redwood Trust, is treated as a
Qualified REIT Subsidiary. As such its assets, liabilities, and income are
generally treated as assets, liabilities, and income of Redwood Trust for
purposes of each of the above REIT qualification tests.
TAXABLE REIT SUBSIDIARIES
A Taxable REIT Subsidiary is any corporation in which a REIT owns stock
(directly or indirectly) and for which the REIT and such corporation make a
joint election to classify the corporation as a Taxable REIT Subsidiary.
Effective January 1, 2001, RWT Holdings, Inc., or Holdings, and Redwood Trust
elected to treat Holdings, Sequoia Residential Funding, and Holdings' other
subsidiaries as Taxable REIT Subsidiaries of Redwood Trust. In 2002 and 2003,
Redwood Trust made a Taxable REIT Subsidiary election for Acacia CDO 1, Ltd. and
for Acacia CDO 2, Ltd., Acacia CDO 3, Ltd., and Acacia CDO 4, Ltd., respectively
each newly formed corporations. As Taxable REIT Subsidiaries, they are not
subject to the REIT asset, income, and distribution requirements nor are their
assets, liabilities, or income treated as assets, liabilities, or income of
Redwood Trust for purposes of each of the above REIT qualification tests.
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Redwood Trust generally intends to engage in securitization transactions
(other than certain non-REMIC, debt-for-tax securitizations) through its Taxable
REIT Subsidiaries. In addition, Redwood Trust generally intends to make a
Taxable REIT Subsidiary election with respect to any other corporation in which
it acquires equity or equity-like securities constituting more than 10% by vote
or value of such corporation and that is not otherwise a Qualified REIT
Subsidiary. However, the aggregate value of all of Redwood Trust's Taxable REIT
Subsidiaries must be limited to 20% of the total value of the REIT's assets. In
addition, Redwood Trust will be subject to a 100% penalty tax on any rent,
interest, or other charges that it imposes on any Taxable REIT Subsidiary in
excess of an arm's length price for comparable services. Redwood Trust expects
that any rents, interest, or other charges imposed on Holdings or any other
Taxable REIT Subsidiary will be at arm's length prices.
Redwood Trust generally expects to derive income from its Taxable REIT
Subsidiaries by way of dividends. Such dividends are not real estate source
income for purposes of the 75% Gross Income Test. Therefore, when aggregated
with Redwood Trust's other non-real estate source income, such income must be
limited to 25% of the REIT's gross income each year. Redwood Trust will monitor
the value of its investment in, and the distributions from, its Taxable REIT
Subsidiaries to ensure compliance with all applicable REIT income and asset
tests.
Taxable REIT Subsidiaries doing business in the United States are
generally subject to corporate level tax on their net income and generally will
be able to distribute only net after-tax earnings to its stockholders, including
Redwood Trust, as dividend distributions. Acacia CDOs are considered foreign
subsidiaries not engaged in trade or business in the United States for tax
purposes and therefore are not subject to U.S. corporate income taxation
(although income from our equity investments in the Acacia CDOs is generally
includable in REIT taxable income or the taxable income of our other Taxable
REIT Subsidiaries that are its stockholders). There is no guarantee that the IRS
will not take the position that Acacia CDOs are doing business in the U.S.,
which position, if sustained, would subject them to corporate level tax on their
effectively connected U.S. trade or business income. If this were to occur, then
the Acacia CDOs would generally only be able to contribute net after-tax
earnings to REIT dividend distributions.
TAXATION OF REDWOOD TRUST
In any year in which Redwood Trust qualifies as a REIT, Redwood Trust will
generally not be subject to federal income tax on that portion of its REIT
taxable income or capital gain that is distributed to its stockholders. Redwood
Trust will, however, be subject to federal income tax at normal corporate income
tax rates upon any undistributed taxable income or capital gain.
In addition, notwithstanding its qualification as a REIT, Redwood Trust
may also be subject to tax in certain other circumstances. As described above,
if Redwood Trust fails to satisfy the REIT Gross Income Tests, but nonetheless
maintains its qualification as a REIT because certain other requirements are
met, it will generally be subject to a 100% tax on the greater of the amount by
which Redwood Trust fails either the 75% or the 95% Gross Income Test. Redwood
Trust will also be subject to a tax of 100% on net income derived from any
"prohibited transaction," which refers to dispositions of property classified as
"property held for sale to customers in the ordinary course of business" (i.e.,
"dealer" property). Redwood Trust does not believe that it has or will engage in
transactions that would result in it being classified as a dealer or deemed to
have disposed of dealer property; however, there can be no assurance that the
IRS will agree. If Redwood Trust has (i) net income from the sale or other
disposition of "foreclosure property" which is held primarily for sale to
customers in the ordinary course of business or (ii) other non-qualifying income
from foreclosure property, it will be subject to federal income tax on such
income at the highest corporate income tax rate. In addition, a nondeductible
excise tax, equal to 4% of the excess of required distributions over the amounts
actually distributed will be imposed on Redwood Trust for each calendar year to
the extent that dividends paid during the year, or declared during the last
quarter of the year and paid during January of the succeeding year, are less
than the sum of (1) 85% of Redwood Trust's "ordinary income," (2) 95% of Redwood
Trust's capital gain net income, plus (3) any undistributed income remaining
from earlier years. Redwood Trust may also be subject to the corporate
alternative minimum tax, as well as other taxes in certain situations not
presently contemplated.
If Redwood Trust fails any of the above described REIT qualification tests
in any tax year and the relief provisions provided by the Code do not apply,
Redwood Trust would be subject to federal income tax (including any applicable
alternative minimum tax) on its taxable income at the regular corporate income
tax rates. Distributions to stockholders in any year in which Redwood Trust
fails to qualify as a REIT would not be deductible by Redwood Trust, nor would
distributions generally be required to be made under the Code. Further,
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unless entitled to relief under certain other provisions of the Code, Redwood
Trust would also be disqualified from re-electing REIT status for the four tax
years following the year in which it became disqualified.
Redwood Trust may also voluntarily revoke its election to be taxed as a
REIT, although it has no intention of doing so, in which event Redwood Trust
will be prohibited, without exception, from electing REIT status for the year to
which the revocation relates and the following four tax years.
Redwood Trust intends to monitor on an ongoing basis its compliance with
the REIT requirements described above. In order to maintain its REIT status,
Redwood Trust may be required to limit the types of assets that it might
otherwise acquire, or hold certain assets at times when it might otherwise have
determined that the sale or other disposition of such assets would have been
more prudent.
TAXATION OF STOCKHOLDERS
For any tax year in which Redwood Trust is treated as a REIT for federal
income tax purposes, distributions (including constructive or in-kind
distributions) made to holders of common stock other than tax-exempt entities
(and not designated as capital gain dividends) will generally be subject to tax
as ordinary income to the extent of Redwood Trust's current and accumulated
earnings and profits as determined for federal income tax purposes. If the
amount distributed exceeds a stockholder's allocable share of such earnings and
profits, the excess will be treated as a return of capital to the extent of the
stockholder's adjusted basis in the common stock, which will not be subject to
tax, and thereafter as a taxable gain from the sale or exchange of a capital
asset.
Distributions designated by Redwood Trust as capital gain dividends will
generally be subject to tax as long-term capital gain to stockholders, to the
extent that the distribution does not exceed Redwood Trust's actual net capital
gain for the tax year. Alternatively, Redwood Trust can also elect by written
notice to its stockholders to designate a portion of its net capital gain income
as being retained and pay directly the tax on such net capital gains. In that
instance, each stockholder generally be required to include the deemed capital
gains dividend in its income, will be entitled to claim a credit or refund on
its tax return for the tax paid by Redwood Trust with respect to such deemed
dividend, and will be entitled to increase its tax basis in Redwood Trust shares
by an amount equal to the excess of the deemed capital gain dividend over the
tax deemed paid by it.
Distributions by Redwood, whether characterized as ordinary income or as
capital gain, are not eligible for the corporate dividends received deduction
that exists under current law. Furthermore, distributions by Redwood
characterized as ordinary income will generally are not subject to the reduced
15% and 5% tax rates otherwise effective for certain types of dividends as of
January 1, 2003. However, dividend distributions by Redwood characterized as
capital gain distributions recognized subsequent to May 5, 2003, will be subject
to the reduced 5% and 15% tax rates made effective by the Jobs and Growth Relief
Reconciliation Tax Act of 2003.
In the event that Redwood Trust realizes a loss for the tax year,
stockholders will not be permitted to deduct any share of that loss. Further, if
Redwood Trust (or a portion of its assets) were to be treated as a taxable
mortgage pool, or if it were to hold residual interests in real estate mortgage
investment conduits, or REMICs, or financial asset securitization investment
trusts, or FASITs, any "excess inclusion" income derived therefrom and allocated
to a stockholder would not be allowed to be offset by a net operating loss of
such stockholder.
Dividends declared during the last quarter of a tax year and actually paid
during January of the following tax year are generally treated as if received by
the stockholder on December 31 of the tax year in which they are declared and
not on the date actually received. In addition, Redwood Trust may elect to treat
certain other dividends distributed after the close of the tax year as having
been paid during such tax year, but stockholders will be treated as having
received such dividend in the tax year in which the distribution is made.
Generally, a dividend distribution of earnings from a REIT is considered
for estimated tax purposes only when the dividend is made. However, any person
owning at least 10% of the vote or value of a closely-held REIT must accelerate
recognition of year-end dividends received from the REIT in computing estimated
tax payments. Redwood Trust is not currently, and does not intend to be, a
closely-held REIT.
Upon a sale or other disposition of the common stock, a stockholder will
generally recognize a capital gain or loss in an amount equal to the difference
between the amount realized and the stockholder's adjusted basis in such stock,
which gain or loss generally will be long-term if the stock was held for more
than twelve months. Any loss on the sale or exchange of common stock held by a
stockholder for six months or less will
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generally be treated as a long-term capital loss to the extent of designated
capital gain dividends received by such stockholder. If stock is sold after a
record date but before a payment date for declared dividends on such stock, a
stockholder will nonetheless be required to include such dividend in income in
accordance with the rules above for distributions, whether or not such dividend
is required to be paid over to the purchaser.
DRP participants will generally be treated as having received a dividend
distribution, subject to tax as ordinary income, in an amount equal to the fair
market value of the common stock purchased with the reinvested dividend proceeds
generally on the date Redwood Trust credits such common stock to the DRP
participant's account, plus brokerage commissions, if any, allocable to the
purchase of such common stock. DRP participants will have a tax basis in the
shares equal to such value. DRP participants may not, however, receive any cash
with which to pay the resulting tax liability. Shares received pursuant to the
DRP will have a holding period beginning on the day after their purchase by the
plan administrator.
If Redwood Trust makes a distribution of stockholder rights with respect
to its common stock, such distribution generally will not be treated as taxable
when made. However, if the fair market value of the rights on the date of
issuance is 15% or more of the value of the common stock, or if the stockholder
so elects regardless of the value of the rights, the stockholder must make an
allocation of its existing tax basis between the rights and the common stock
based on their relative value on the date of the issuance of the rights. On the
exercise of the rights, the stockholder will generally not recognize gain or
loss. The stockholder's basis in the shares received from the exercise of the
rights will be the amount paid for the shares plus the basis, if any, of the
rights exercised. Distribution of stockholder rights with respect to other
classes of securities holders generally would be taxable based on the value of
the rights on the date of distribution.
Redwood Trust is required under Treasury Department regulations to demand
annual written statements from the record holders of designated percentages of
its stock disclosing the actual and constructive ownership of such stock and to
maintain permanent records showing the information it has received as to the
actual and constructive ownership of such stock and a list of those persons
failing or refusing to comply with such demand.
In any year in which Redwood Trust does not qualify as a REIT,
distributions made to its stockholders would be taxable in the same manner
discussed above, except that no distributions could be designated as capital
gain dividends, distributions would be eligible for the corporate dividends
received deduction and may be eligible for the reduced tax rates on dividends
(if paid out of previously-taxed earnings), the excess inclusion income rules
would not apply, and stockholders would not receive any share of Redwood Trust's
tax preference items. In such event, however, Redwood Trust would be subject to
potentially substantial federal income tax liability, and the amount of earnings
and cash available for distribution to its stockholders could be significantly
reduced or eliminated.
TAXATION OF TAX-EXEMPT ENTITIES
Subject to the discussion below regarding a "pension-held REIT," a
tax-exempt stockholder is generally not subject to tax on distributions from
Redwood Trust or gain realized on the sale of the common stock or preferred
stock, provided that such stockholder has not incurred indebtedness to purchase
or hold Redwood Trust's common stock or preferred stock, that its shares are not
otherwise used in an unrelated trade or business of such stockholder, and that
Redwood Trust, consistent with its stated intent, does not form taxable mortgage
pools or hold residual interests in REMICs or FASITs that give rise to "excess
inclusion" income as defined under the Code. However, if Redwood Trust was to
hold a residual interest in a REMIC or FASIT, or if a pool of its assets were to
be treated as a "taxable mortgage pool," a portion of the dividends paid to a
tax-exempt stockholder may be subject to tax as unrelated business taxable
income or UBTI. Although Redwood Trust does not intend to acquire such residual
interests or believe that it, or any portion of its assets, will be treated as a
taxable mortgage pool, no assurance can be given that the IRS might not
successfully maintain that such a taxable mortgage pool exists.
If a qualified pension trust (i.e., any pension or other retirement trust
that qualifies under Section 401(a) of the Code) holds more than 10% by value of
the interests in a "pension-held REIT" at any time during a tax year, a
substantial portion of the dividends paid to the qualified pension trust by such
REIT may constitute UBTI. For these purposes, a "pension-held REIT" is a REIT
(i) that would not have qualified as a REIT but for the provisions of the Code
which look through qualified pension trust stockholders in determining ownership
of stock of the REIT and (ii) in which at least one qualified pension trust
holds more than 25% by value of the interest of such REIT or one or more
qualified pension trusts (each owning more than a 10% interest by value
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in the REIT) hold in the aggregate more than 50% by value of the interests in
such REIT. Assuming compliance with the ownership limit provisions in Redwood
Trust's Articles of Incorporation it is unlikely that pension plans will
accumulate sufficient stock to cause Redwood Trust to be treated as a
pension-held REIT.
Distributions to certain types of tax-exempt stockholders exempt from
federal income taxation under Sections 501 (c)(7), (c)(9), (c)(17), and (c)(20)
of the Code may also constitute UBTI, and such prospective investors should
consult their tax advisors concerning the applicable "set aside" and reserve
requirements.
STATE AND LOCAL TAXES
Redwood Trust and its stockholders may be subject to state or local
taxation in various jurisdictions, including those in which it or they transact
business or reside. The state and local tax treatment of Redwood Trust and its
stockholders may not conform to the federal income tax consequences discussed
above. Consequently, prospective stockholders should consult their own tax
advisors regarding the effect of state and local tax laws on an investment in
the common stock.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS
The following discussion summarizes certain United States Federal tax
consequences of the acquisition, ownership and disposition of common stock or
preferred stock by an initial purchaser that, for United States federal income
tax purposes, is a "Non-United States Holder." Non-United States Holder is any
beneficial holder that is: not a citizen or resident of the United States; not a
corporation, partnership, or other entity created or organized in the United
States or under the laws of the United States or of any political subdivision
thereof; and not an estate or trust whose income is includible in gross income
for United States federal income tax purposes regardless of its source. This
discussion does not consider any specific facts or circumstances that may apply
to particular Non-United States Holder's acquiring, holding, and disposing of
common stock or preferred stock, or any tax consequences that may arise under
the laws of any foreign, state, local, or other taxing jurisdiction.
DIVIDENDS
Dividends paid by Redwood Trust out of earnings and profits, as determined
for United States federal income tax purposes, to a Non-United States Holder
will generally be subject to withholding of United States federal income tax at
the rate of 30%, unless reduced or eliminated by an applicable tax treaty or
unless such dividends are treated as effectively connected with a United States
trade or business. Distributions paid by Redwood Trust in excess of its earnings
and profits will be treated as a tax-free return of capital to the extent of the
holder's adjusted basis in his shares, and thereafter as gain from the sale or
exchange of a capital asset as described below. If it cannot be determined at
the time a distribution is made whether such distribution will exceed the
earnings and profits of Redwood Trust, the distribution will be subject to
withholding at the same rate as dividends. Amounts so withheld, however, will be
refundable or creditable against the Non-United States Holder's United States
Federal tax liability if it is subsequently determined that such distribution
was, in fact, in excess of the earnings and profits of Redwood Trust. If the
receipt of the dividend is treated as being effectively connected with the
conduct of a trade or business within the United States by a Non-United States
Holder, the dividend received by such holder will be subject to the United
States federal income tax on net income that applies to United States persons
generally (and, with respect to corporate holders and under certain
circumstances, the branch profits tax).
For any year in which Redwood Trust qualifies as a REIT, distributions to
a Non-United States Holder that are attributable to gain from the sales or
exchanges by Redwood Trust of "United States real property interests" will be
treated as if such gain were effectively connected with a United States business
and will thus be subject to tax at the normal capital gain rates applicable to
United States stockholders (subject to applicable alternative minimum tax) under
the provisions of the Foreign Investment in Real Property Tax Act of 1980, or
FIRPTA. Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled to a
treaty exemption. Redwood Trust is required to withhold 35% of any distribution
that could be designated by Redwood Trust as a capital gains dividend. This
amount may be credited against the Non-United States Holder's FIRPTA tax
liability. It should be noted that mortgage loans without substantial equity or
with shared appreciation features generally would not be classified as "United
States real property interests."
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GAIN ON DISPOSITION
A Non-United States Holder will generally not be subject to United States
federal income tax on gain recognized on a sale or other disposition of its
shares of either common or preferred stock unless (i) the gain is effectively
connected with the conduct of a trade or business within the United States by
the Non-United States Holder, (ii) in the case of a Non-United States Holder who
is a nonresident alien individual and holds such shares as a capital asset, such
holder is present in the United States for 183 or more days in the tax year and
certain other requirements are met, or (iii) the Non-United States Holder is
subject to tax under the FIRPTA rules discussed below. Gain that is effectively
connected with the conduct of a business in the United States by a Non-United
States Holder will be subject to the United States federal income tax on net
income that applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits tax) but
will not be subject to withholding. Non-United States Holders should consult
applicable treaties, which may provide for different rules.
Gain recognized by a Non-United States Holder upon a sale of either common
stock or preferred stock will generally not be subject to tax under FIRPTA if
Redwood Trust is a "domestically-controlled REIT," which is defined generally as
a REIT in which at all times during a specified testing period less than 50% in
value of its shares were held directly or indirectly by non-United States
persons. Because only a minority of Redwood Trust's stockholders are believed to
be Non-United States Holders, Redwood Trust anticipates that it will qualify as
a "domestically-controlled REIT." Accordingly, a Non-United States Holder should
not be subject to United States federal income tax from gains recognized upon
disposition of its shares.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Redwood Trust will report to its U.S. stockholders and the Internal
Revenue Service the amount of distributions paid during each calendar year, and
the amount of tax withheld, if any. Under the backup withholding rules, a
stockholder may be subject to backup withholding with respect to distributions
paid (at the rate generally equal to the fourth lowest rate of federal income
tax then in effect) unless such holder (a) is a corporation or comes within
certain other exempt categories and, when required, demonstrates that fact; or
(b) provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with applicable
requirements of the backup withholding rules. A stockholder that does not
provide Redwood Trust with its correct taxpayer identification number may also
be subject to penalties imposed by the IRS. Any amount paid as backup
withholding will be creditable against the stockholder's income tax liability.
In addition, Redwood Trust may be required to withhold a portion of dividends
and capital gain distributions to any stockholders that do not certify under
penalties of perjury their non-foreign status to Redwood Trust.
PLAN OF DISTRIBUTION
We may sell securities to or through one or more underwriters or dealers
for public offering and sale, to one or more investors directly or through
agents, to existing holders of our securities directly through the issuance of
stockholders rights as a dividend, or through any combination of these methods
of sale. Any principal underwriter or agent involved in the offer and sale of
the securities will be named in the applicable prospectus supplement.
The distribution of the securities may be effected from time to time in
one or more transactions at a fixed price or prices, which may be changed, at
market prices prevailing at the time of sale, at prices related to such
prevailing market prices, or at negotiated prices (any of which may represent a
discount from the prevailing market prices). We may also sell our securities
from time to time through one or more agents in ordinary brokers' transactions.
Such sales may be effected during a series of one or more pricing periods at
prices related to the prevailing market prices reported on the New York Stock
Exchange, as shall be set forth in the applicable prospectus supplement.
In connection with the sale of securities, underwriters or agents may
receive compensation from us or from purchasers of securities, for whom they may
act as agents, in the form of discounts, concessions or commissions.
Underwriters may sell securities to or through dealers, and such dealers may
receive compensation in the form of discounts, concession or commissions from
the underwriters and/or commissions from the purchasers for whom they may act as
agents. Underwriters, dealers and agents that participate in the distribution of
securities may be deemed to be underwriters under the Securities Act, and any
discounts or commissions they receive from us and any profit on the resale of
securities they realize may be deemed to be underwriting
15
discounts and commissions under the Securities Act. Any principal underwriter or
agent will be identified, and any such compensation received from us will be
described, in the applicable prospectus supplement.
Unless otherwise specified in the related prospectus supplement, each
class or series of securities will be a new issue with no established trading
market, other than the common stock which is listed on the New York Stock
Exchange. Any shares of common stock sold pursuant to a prospectus supplement
will also be listed on the New York Stock Exchange, subject to official notice
of issuance. We may elect to list any future class or series of securities on an
exchange, but we are not obligated to do so. It is possible that one or more
underwriters may make a market in a future class or series of securities, but
they will not be obligated to do so and they may discontinue any market making
at any time without notice. Therefore, no assurance can be given as to the
liquidity of, or the trading market for, the securities.
In connection with the offering of securities hereby, underwriters and
selling group members and their respective affiliates may engage in transactions
that stabilize, maintain or otherwise affect the market price of the applicable
securities. These transactions may include stabilization transactions affected
in accordance with Rule 104 of Regulation M promulgated by the SEC pursuant to
which these persons may bid for or purchase securities for the purpose of
stabilizing their market price.
The underwriters in an offering of securities may also create a "short
position" for their account by selling more securities in connection with the
offering than they are committed to purchase from us. In that case, the
underwriters could cover all or a portion of the short position by either
purchasing securities in the open market following completion of the offering of
these securities or by exercising any over-allotment option granted to them by
us. In addition, the managing underwriter may impose penalty bids under
contractual arrangements with other underwriters, which means that they can
reclaim from an underwriter, or any selling group member participating in the
offering, for the account of the other underwriters, the selling concession for
the securities that are distributed in the offering but subsequently purchased
for the account of the underwriters in the open market. Any of the transactions
described in this paragraph or comparable transactions that are described in any
accompanying prospectus supplement may result in the maintenance of the price of
the securities at a level above that which might otherwise prevail in the open
market. None of the transactions described in this paragraph or in an
accompanying prospectus supplement are required to be taken by any underwriters
and, if they are undertaken, may be discontinued at any time.
The underwriters, dealers or agents used by us in any offering of
securities under this prospectus may be customers of, including borrowers from,
engage in transactions with, and perform services for, us or one or more of our
affiliates in the ordinary course of business.
Underwriters, dealers, agents and other persons may be entitled, under
agreements that they may enter into with us, to indemnification against civil
liabilities, including liabilities under the Securities Act.
If indicated in the applicable prospectus supplement, we will authorize
agents and underwriters to solicit offers by institutions to purchase securities
from us at the public offering price set forth in the prospectus supplement
pursuant to delayed delivery contracts providing for payment and delivery on the
date stated in the prospectus supplement. Each contract will be for an amount
not less than, and, unless we otherwise agree, the aggregate principal amount of
securities sold pursuant to contracts shall be not less nor more than, the
respective amounts stated in the prospectus supplement. Institutions with whom
contracts, when authorized, may be made include commercial and savings banks,
insurance companies, pension funds, investment companies, educational and
charitable institutions and other institutions, but shall in all cases be
subject to our approval. Contracts will not be subject to any conditions except
that the purchase by an institution of the securities covered by its contract
shall not at the time of delivery be prohibited under the laws of any
jurisdiction in the United States to which that institution is subject. A
commission indicated in the prospectus supplement will be paid to the
underwriters and agents soliciting purchases of debt securities pursuant to
contracts accepted by us.
Until the distribution of the securities is completed, rules of the SEC
may limit the ability of the underwriters and selling group members, if any, to
bid for and purchase the securities. As an exception to these rules, the
representatives of the underwriters, if any, are permitted to engage in
transactions that stabilize the price of the securities. Such transactions may
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of securities.
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ERISA INVESTORS
Because the common stock will qualify as a "publicly offered security,"
employee benefit plans and individual retirement accounts may purchase shares of
common stock and treat such shares, and not the underlying assets, as plan
assets. The status of securities offered hereby other than the common stock will
be discussed in the relevant prospectus supplement. Fiduciaries of ERISA plans
should consider (i) whether an investment in the common stock and other
securities offered hereby satisfies ERISA diversification requirements, (ii)
whether the investment is in accordance with the ERISA plans' governing
instruments and (iii) whether the investment is prudent.
LEGAL MATTERS
The validity of the securities offered hereby and certain legal matters
will be passed on for us by Tobin & Tobin, a professional corporation, San
Francisco, California. Certain tax matters will be passed on by Chapman and
Cutler LLP, San Francisco, California.
EXPERTS
The financial statements incorporated in this Prospectus by reference to
the Annual Report on Form 10-K for the year ended December 31, 2003, have been
so incorporated in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission or the SEC. Our SEC
filings are available to the public over the Internet at the SEC's web site at
http://www.sec.gov. You may also read and copy any document we file at the SEC's
public reference facilities maintained by the Commission at Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C., 20549, New York, New York, and
Chicago, Illinois. Please call the SEC at 1-800-SEC-0300 for further information
on the public reference rooms.
We have filed a registration statement, of which this prospectus is a
part, covering the securities offered hereby. As allowed by SEC rules, this
prospectus does not contain all the information set forth in the registration
statement and the exhibits, financial statements and schedules thereto. We refer
you to the registration statement, the exhibits, financial statements and
schedules thereto for further information. This prospectus is qualified in its
entirety by such other information. You may request a free copy of any of the
above filings by writing or calling:
Redwood Trust, Inc.
One Belvedere Place, Suite 300
Mill Valley, CA 94941
(415) 389-7373
You should rely only on the information provided in this prospectus. We
have not authorized anyone else to provide you with different information. You
should not assume that the information in this prospectus is accurate as of any
date other than the date on the cover page of this prospectus.
INCORPORATION BY REFERENCE
The Commission allows us to "incorporate by reference" information into
this prospectus, which means that we can disclose important information to you
by referring you to another document filed separately with the Commission. The
information incorporated by reference is deemed to be part of this prospectus,
except for any information superseded by information in this prospectus.
We have filed the documents listed below with the Commission under the
Securities Exchange Act of 1934 (the "Exchange Act"), and these documents are
incorporated herein by reference:
- Our Annual Report on Form 10-K for the year ended December 31, 2003;
- Our Definitive Proxy Statement on Schedule 14A filed April 2, 2004;
- Our Annual Report on Form 10-Q for the three months ended March 31,
2004; and
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- The description of our common stock included in our registration
statement on Form 8-A, filed July 18, 1995 (Registration No.
0-26434) and as amended by Form 8-A/A filed August 4, 1995, under
the Exchange Act.
Any documents we file pursuant to Sections 13(a), 13(c), 14 or 15(d) of
the Exchange Act after the date of this prospectus and prior to the termination
of the offering of the securities to which this prospectus relates will
automatically be deemed to be incorporated by reference in this prospectus and
to be part hereof from the date of filing those documents. Any documents we file
pursuant to these sections of the Exchange Act after the date of the initial
registration statement that contains this prospectus and prior to the
effectiveness of the registration statement will automatically be deemed to be
incorporated by reference in this prospectus and to be part hereof from the date
of filing those documents.
Any statement contained in this prospectus or in a document incorporated
by reference shall be deemed to be modified or superseded for all purposes to
the extent that a statement contained in this prospectus or in any other
document which is also incorporated by reference modifies or supersedes that
statement. You may obtain copies of all documents which are incorporated in this
prospectus by reference (other than the exhibits to such documents unless the
exhibits are specifically incorporated herein by reference in the documents that
this prospectus incorporates by reference) without charge upon written or oral
request to Redwood Trust, Inc., One Belvedere Place, Suite 300, Mill Valley, CA
94941, telephone (415) 389-7373.
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